Benefitfocus Inc (BNFT) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Benefitfocus third-quarter 2013 earnings conference call.

(Operator Instructions)

Thank you. I would now like to turn the call over to Milt Alpern. CFO of Benefitfocus. You may begin.

Thank you operator, and good afternoon everyone, and welcome to Benefitfocus' third-quarter 2013 earnings call. We will be discussing the operating results announced in our press release issued after the close of the market today. I'm Milt Alpern, CFO of Benefitfocus, and with me on the call today is Shawn Jenkins, our President and CEO.

As a reminder, today's discussion will include forward-looking statements, such as predictions, expectations, and other information that might be considered forward-looking under federal security laws. These statements reflect our views as of today only, and should not be considered as representing our views as of any subsequent date.

These statements are subject to a variety of risks and uncertainties, including the 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 final prospectus to our IPO, which is on file with the SEC.

Also during the course of today's call we will refer to certain non-GAAP financial measures. There is a reconciliation schedule showing GAAP versus non-GAAP results currently available in our press release issued after the close of market today, which is located on a website at www.benefitfocus.com.

With that, let me turn the call over to Shawn, and then I will come back at the end to provide details regarding our third-quarter results, as well as our guidance for the fourth quarter and the full year 2013.

Super. Thanks Milt, and thanks to all of you for joining us today for our very first quarterly earnings call as a public company. We are pleased to report strong third-quarter results, which reflect the strong and growing demand for cloud-based benefits management solutions from both employers and carriers.

We crossed $100 million in annualized revenue level during the third quarter, representing a milestone event for Benefitfocus. Our total revenue of $26.3 million for the third quarter increased 26% year over year, and was highlighted by employer revenue growth of 66%. Moreover, the positive impact of our revenue mix shift toward our rapidly growing employer businesses is driving an acceleration in overall revenue growth profile.

As we look ahead, we are very excited by the future for Benefitfocus as we continue to solidify our position as a leading software provider in the cloud-based benefits management industry. Our recent IPO will help to further increase our market awareness, and provides us with an increased resources to invest in our strategic growth initiatives.

We believe we are in the very early stages of a multibillion dollar market opportunity, and believe that Benefitfocus is well positioned to create a very large company over time. Since this is our first call as a public company, I want to take up a couple minutes to provides some background on what Benefitfocus does, our market opportunity, and our growth drivers.

We were founded with the vision to transform the way that benefits are managed and purchased. We've spent the last 13 years building a world-class multi-tenant cloud-based management platform that is able to address both key markets in this industry. They are employers and insurance carriers.

This are complimentary markets that are both facing similar secular trends that are driving the move to the cloud-based benefits management solution. We estimate our combined total addressable market to be well over $10 billion.

The fastest-growing segment, and where we are placing a lot of incremental resources, is the employer market. We have over a decade of deep domain expertise handling the complexities of benefits management, and we are well positioned to address the broad market opportunity represented by over 18,000 large employers in the United States with more than 1000 employees.

Currently we have 379 large employer customers, which we believe represents a long runway for strong growth in the years ahead. At the same time, Gartner estimates that insurance carriers spend $55 billion annually on software and services, which creates another multibillion dollar market opportunity for Benefitfocus, one where we believe we already have established a clearly leadership position.

The traditional benefits enrollment administration process is cumbersome, frustrating, and expensive and it does not does not provide employers with the flexibility they need to offer more customized benefits packages. This is a significant problem for employers who are spending more than $1.6 trillion each year on benefits. This represent over 30% of employee compensation expense.

Compounding this is the fact that health benefits have been going well above the rate of inflation in the United States for a number of years, and represents one of the fastest-growing expense categories for most employers.

There's also a growing trend, which we expect to accelerate over the next several years, of employers moving from a defined-benefit model to a more defined-contribution offering. This is a result of employers looking to bring greater cost certainty to their business while empowering their employees to create the benefits package that is right for their unique circumstances.

Insurance carriers face similar pressures on their business. As their enrollment processes and billing systems they are largely paper-based and inefficient. At the same time, the rise of defined-contribution plans has presented carriers an opportunity to build private exchanges that allow them to provide personalized plans to the group and individual markets. And for the first time, provide a transparent shopping experience.

Increasingly, carriers recognize the only long-term way to improve their core processes while also positioning themselves to successfully compete in an increasingly dynamic marketplace is through a cloud-based benefits management platform. Our platform represents -- addresses the challenges that employers and carriers are facing by encompassing the entire benefits management lifecycle, which we referred to refer to as our four verbs, These are shop, enroll, manage, and exchange.

Shop enables employers and employees to compare different benefit plans and combine them with voluntary benefit programs that are right for them in an intuitive web-based shopping experience that is simple to navigate as the best e-commerce website today. This consumerization of IT requires a fundamentally different approach to benefits management that empowers employees to take control of their benefits experience.

Enroll provides a proactive self-service enrollment process that provides improved communication with employees and automates all the complex processes related to things like eligibility verification, on boarding new employees, and synchronizing deductions with payroll systems that historically has been paper-based. Manage allow employers to manage their benefit programs on an ongoing basis, and make it simple to complete common tasks like adding, deactivating, and rehiring employees, changing employee categories, and initiating life events which can dramatically improve the efficiency of the benefits management process.

And finally, exchange refers to the more than 900 data connections we have built among carriers, supplemental benefit providers, and other vendors through our platform that allows seamless information sharing. This is a highly differentiation aspect of our solution that has taken us over 10 years to build and would be very difficult to replicate.

On top of our core benefits platform, we have a rich data analytics solution called Benefit Informatics that can turn the vast amount of claims data generated on the platform into an asset that can drive improved benefit plan designs. By far the most powerful driver of demand for solutions is the clear shift to the cloud in an application category that addresses one of the largest and most inefficiently managed areas of spend among employers.

We believe this factor alone can fuel strong growth for Benefitfocus over the next decade. On top of this, we believe we have an extra tailwind at our back due to move to a defined-contribution plans that I just described a moment ago.

Further, we believe that healthcare reform and the implementation of the Affordable Care Act have further increased the regulatory complexity of benefits management, which is always a positive for Benefitfocus. Over time, we believe the only cost-effective way to comply with this increased regulatory burden while also managing the migration of tens of millions of people in the individual insurance marketplace is through a cloud-based platform like Benefitfocus.

It is worth recognizing there has been a lot of focus in recent weeks on the rollout of the public healthcare exchanges. We made the decision several years ago that the level of customization required for these public exchanges did not fit our business model. So we made the decision not to pursue this business, and instead focused our resources in other areas to drive sustainable growth.

While we expect the performance of these public exchanges will improve, it is also argued that the most policies is will end up being bought through private exchanges over the long term, and as such, that is where we have focused.

Let me turn to some of the highlights of our third-quarter performance in more detail. We saw good momentum in both of our business, as I noted earlier, wile also spending a good amount of time and focus preparing for a record number of expected go-lives in the fourth quarter. During the quarter, we added 31 new employers, including Fiesta Restaurant Group, Sears Hometown and Outlets Stores, Sprouts Farmers Market, Stolt-Nielsen, and Western Kentucky University, among others.

With strong market demand, additional growth capital from our IPO, and proven returns on our investment we plan to continue expanding our employers sales capacity to ramp our customer base. An exciting example of our expanding employers sales reach was Mercer's recent announcement that it has signed 33 employers onto its Mercer Marketplace for the 2014 plan year, representing more than 200,000 lives on the platform. We are very excited by the early success Mercer is having with its private exchange, and we think it is indicative of the type of success this new distribution model could have in the market.

In our carrier business we had a very successful quarter as we prepared for a record number of new projects with customers such as Aetna and many of Blue Cross/Blue Shield plans for a very busy October 1 and fourth quarter. This year is the most substantial open enrollment season in Benefitfocus history due to the significant changes in regulatory environment and the expansion of our customer base.

I am extremely proud of what we were able to accomplish against a hard deadline, and would like to recognize the great work done by all of our associates in our engineering, product support, and customer service groups. One of the underlying reasons Benefitfocus has been so successful over the years is our level of innovation.

We deliver the most comprehensive scalable and easy-to-use benefits platform in the industry. Continuing to extend our technology and product leadership is a key priority as we move forward. To that point, we are very excited to have recently announced the availability of HR InTouch mobile, which is an app providing full access to our core HR InTouch employer platform that allows employees to manage and access their benefits information on native iOS and Android devices.

During the quarter we also released the cost share estimator, an exciting new product enhancement to our Benefit Informatics solution. This new functionality allows a company administrator to evaluate the impact of key changes in plan design on the overall benefits program, as well as covered individuals.

We also recently created a collaboration with Thompson's, a leading UK-based online benefits software provider. This collaboration will enable Benefitfocus customers with international operations to use Thompson's Darwin product to manage employee benefits for their offshore subsidiaries, and will also will Thomson's customers to use our HR InTouch platform to manage their US-based employees' benefits. Expanding internationally is a long-term opportunity for Benefitfocus, and this collaboration represents a cost-effective way for us to gain greater insight into how to best approach this opportunity.

The great example of our expanding ecosystem was our recent announcement of a strategic alliance with Equifax, which makes Equifax's Look-Back calculator available through HR InTouch. This provides employers a fast and cost-effective way to accurately track and calculate the eligibility of hourly workforce populations for benefit offerings, which is a requirement under ACA.

The new integrated capability will also use advanced multimedia messaging to notify employees of eligibility and ensure that they enroll in the appropriate benefit plans within the required 90 day time frame.

In summary, this is a very exciting time for Benefitfocus. The move to the cloud is upon us, and we believe we are in the first inning of a once-in-a-generation re-architecting of the benefits management infrastructure for employers and insurance carriers. We have strong momentum and believe that Benefitfocus is uniquely positioned to capture a large portion of this market opportunity over time.

With that, I'd like to turn it back over to Milt.

Thanks, Shawn. And I'd also like to reiterate how pleased we are with the Company's performance in the third quarter. I will review our third-quarter financial results, as well as our guidance for the fourth quarter and full year 2013 in detail in a moment.

Before doing so, I want to quickly review our financial model as this is our first quarter as a public Company. We generate revenue from two sources, software revenue as well as professional services revenue related to the one-time upfront implementation of our products.

Our employee contracts are typically annual contracts with evergreen renewals, while our carrier business is characterized by long-term contracts which typically range from 4 to 10 years in length. The combination of our software-to-service business model, along with very high renewal rates, provides us with a high degree of visibility into our future revenues.

From an invoicing perspective, we bill our customers on a monthly basis, based on the number of lives they have on our platform. As a result, we do not believe it is meaningful to look at changes in our deferred revenue as an indicator of the business momentum for Benefitfocus, as it may be for companies that invoice customers on an annual upfront basis.

Another aspect of our business model is worth noting. Is that we the defer the recognition of professional services revenue until the customer is live on our platform. Once that's occurred, we recognize the revenue ratably over the length of our customer relationship period, which we have determined to be 10 years.

While this provides for significant visibility into future professional services revenue, it does artificially lower our gross margin for a short-term perspective, because we recognize the expense of our professional services delivery as those expenses are incurred. Over time, as deferred professional services revenue is recognized, it will become tailwinds to our gross margin profile.

With that background, let's review our results for the third quarter. Total revenue was $26.3 million, an increase of 26% compared to the third quarter of 2012. Within total revenue, software subscription revenue was $24.5 million, representing 93% of our revenue and growing 29% year over year.

Professional services revenue was $1.8 million, which represented the remaining 7% of our revenue, and it was up modestly over the prior year period. Looking at our revenue by segments, employer revenue for the quarter was $9.8 million which represented 66% growth compared to the year ago period, while our carrier revenue was $16.5 million, up 11% from a year ago period.

Our employer business continues to deliver substantial growth, as we add new customers from this underpenetrated multibillion dollar market opportunity. In addition, the increasing percentage of our total revenue coming from the employer side of our business, 37% of our total revenue in the third quarter compared to 28% in year ago quarter, is driving an acceleration in our total revenue growth. From a multi-year perspective we expect our employer revenue will ultimately represent the majority of our total revenue.

Let me review some of the supplemental metrics that we plan on sharing with investors going forward. We ended the quarter with 379 employer customers compared to 269 in the third quarter of 2012 and 348 at the end of last quarter. With over 18,000 potential large employer customers in the United States alone, we are still significantly underpenetrated in the domestic employer market.

We ended the quarter with 37 carrier customers, up from 33 in the third quarter of 2012 and consistent with the end of last quarter. While the employer market is more of a value opportunity, the carrier market is characterized by a smaller number of large customers. We will continue to focus on adding new carrier logos in the domestic market, but much of our near-term carrier revenue growth will continue to come from increasing the penetration within our blue chip customer base, many of whom have only deployed Benefitfocus in certain states or over certain products.

Our software revenue retention rate was greater than 95% in the third quarter, and we've consistently maintained this best-in-class revenue retention rate over time. We believe this is evidenced in the significant value Benefitfocus generates for our customers and it provides us with a substantial revenue visibility.

Moving down the P&L, I will be discussing gross profit on an adjusted basis, which in addition to excluding stock-based compensation and amortization of acquired intangibles, also excludes depreciation and amortization of capitalized software. A reconciliation to GAAP and non-GAAP results is provided in the press release we issued after the close today.

Adjusted gross profit in the third quarter was $11.7 million, representing an adjusted gross margin of 44.5%. This is down from 55.7% adjusted gross margin in the year ago period due to a number of significant professional service contracts we won at the end of 2012 and early 2013 with some of our carrier customers.

As I noted earlier, we recognize expenses for professional services on an upfront basis, but defer the revenue until our customer is live, and then the revenue is amortized over 10 years. As these large projects and their associated expense wind down, and we begin to recognize the associated revenue, we expect that the professional services margins to begin to improve.

Our software gross margins are considerably higher than our service gross margins and reflect the leverage potential in our business as we scale, particularly considering the fact that our software revenue is over 90% of total revenue. We are very confident in our ability to scale our overall gross margins, as well as our software gross margins, as we gain further scale in our business over time.

Turning to operating expenses, on a non-GAAP basis, excluding stock-based compensation and amortization of acquired intangibles, sales and marketing expenses were $7.4 million, an increase of 10% compared to the third quarter of 2012. One of the primary reasons for our IPO was to provide growth capital that would enable Benefitfocus to expand its employer sales organization. With the completion of our IPO in September, you should expect us to begin increasing investments in this area, and sales and marketing should increase as a percentage of our total revenue from a near-term perspective.

R&D expenses were $6.6 million, an increase of 79% compared to the year ago period. We will continue to make significant investments in our product platform in areas like analytics, big data, mobile, and social to further extend our value proposition and market leadership position.

G&A expenses were $2.5 million, an increase of 44% compared to the year ago period. The increase in our G&A expense largely reflects increased cost associated with becoming a public company, in addition to building out the infrastructure to support the growth of our business.

Adjusted EBITDA was a negative $4.5 million, or negative 17% of revenue, compared to a negative $400,000, or negative 2% of revenue, in the third quarter of 2012. The reduction in our adjusted EBITDA margin reflects a focused strategy of increasing investments in sales and product to capitalize on our leadership position in the multibillion dollar market opportunity we have discussed, in addition to the increase costs associated with becoming a public company.

We believe that our investment and growth strategy will enable Benefitfocus to create substantial long-term shareholder value. Over time, as the growth of our employer business moderates, and our business achieves greater scale, we believe that we can increase our adjusted EBITDA margin to the 20% level or better.

Non-GAAP net loss per share was $0.30 based on 21.6 million weighted average shares outstanding. This compares to a per-share loss of $0.10 on 21.3 million weighted shares outstanding in the year ago period. These non-GAAP EPS calculations assume our convertible preferred stock was converted to common stock for the full quarter. Looking quickly at our GAAP results, gross profit was $9.9 million, operating loss was $6.8 million, and our net loss per share was $1.08.

Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $84.7 million, which was an increase from $13.7 million at the end of the second quarter. The increase in cash and equivalents was due to the $70.1 of net proceeds we generated from our initial public offering during the quarter.

Our deferred revenue balance at the end of the third quarter was $72.4 million, which is up from $51.9 million in the third quarter of 2012. Our deferred revenue consists primarily of deferred professional services revenues that we recognized over the 10-year period once that particular customer goes live, which is why the significant majority of our deferred revenues is classified as long term on the balance sheet.

From a cash flow perspective, we generated $2.3 million in cash from operations and invested $6.7 million in capital expenditures and capitalized software during the nine months ended September 30, which equates to a negative $4.4 million of free cash flow. This compares to a positive $1.2 million in free cash flow during the year ago period.

I'd now like to finish with our guidance for the fourth quarter and full year of 2013. For the full year we expect revenues of between $102.5 million and $103.5 million, which equates to year-over-year growth of 25% to 27%. We are targeting an adjusted EBITDA loss of $21.2 million to $21.7 million and a net loss per share of $1.30 to $1.33 based on 22.2 million weighted average shares outstanding.

For the fourth quarter we are targeting revenues of $28 million to $29 million, which represents year-over-year growth of between 26% to 31%. From a profitability perspective, we expect an adjusted EBITDA loss of $6 million to $6.5 million, and a non-GAAP net loss per share of $0.33 to $0.35 based on 24.5 million weighted shares outstanding.

It is worth pointing out that the timing of some of our investments and expenses are expected to incur during the fourth quarter instead of the third quarter as we originally anticipated. Taking both quarters into consideration, we expect to finish the year with a smaller loss than we initially anticipated, due in part to the strength of our top line performance.

In summary, we are very pleased to deliver strong third-quarter results and our first quarter as a public company. We are targeting a dynamic multibillion dollar market opportunity where we have a clear first (inaudible) advantage.

We are making the necessary investments to ensure that we are properly leveraging our unparalleled product platform and domain expertise to capture as much of this market opportunity as possible.

With that, we are now ready to take your questions. Operator, please begin the Q&A.

(Operator Instructions)

First question comes from the line of Greg Dunham with Goldman Sachs.

Hi. Thanks for taking my question. And congrats on the first quarter as a public company. Shawn, the first question is for you. You mentioned how the shift is defined-contribution from defined-benefit and the employee base is a tailwind to the business.

Could you give us a little bit more detail on why it is such a driver to the business? And then put in context of where it is today, and then what the opportunity could be longer-term?

Excellent. Thanks, Greg. And we are extremely excited about our first quarter as a public company and real proud of the results, and I think your hitting on a very key theme that we see as a big tailwind.

It's one of sort of two primary things. This shift of enterprises to the cloud, a better way to manage aspects of their business, in our case the benefits aspect of it. And additionally we see this move from an employer providing really what we commonly refer to as defined-benefit program to a defined-contribution program. And just in context, we all know from our employers how they provide us a set of benefits of a health insurance program, maybe dental and some other programs. And they work out the economics of that and then they present us with those options. And we say yes or no, we will take the medical or we won't take the medical. And that benefit is predetermined.

In the future, in going forward, and to your point about where are we, I think we are really just in the first inning of this massive re-architecting of how employers provide benefits. We are moving to more defined-contribution approach, which is simply the employer defining a contribution, coming up with a fixed sum of money, and providing it, allocating it to the employee, and allowing the employee to basically assemble their own benefits package.

Now, we would say that this happens inside of a marketplace environment where the employer has preselected the options inside the marketplace. So in the old days you'd have a defined benefit. You might have two medical options. In the new world you might have 8 or 10 or a few more, and this allows the individual to really create a benefit package that works for them and allocate the contribution they receive from the employer in the best light. For example, I might be a single individual right of college. I don't need to buy a lot a lot of insurance. Or I might be married with three kids, and I might have a bigger need for various types of insurance. So we can better fit our benefits package to our own personal needs.

It is good for the employer in that they get a knowable contribution. It is also good for the individual because they can really design their own programs. It is a big shift, and it is going to require a lot of education of employees. It is going to create -- require a lot of technology. So we built the Benefitfocus marketplace technology used for these defined-contribution approaches, and it really makes an elegant way for the employee to learn about this. We use a lot of video in our technology to explain how these things are happening.

Sometimes avatars are used inside the user experience. So as the employee goes through and really begins to assume the responsibility of creating their benefit packages, there's a lot of communication that needs to take place. So it's a very exciting theme. It is one of several themes that are happening, and we think it is really just a very early stage of the process.

Okay, great. One more follow-up, if you'll permit. Milt, I know billings is not the best metric to look at you guys, given the fact that you invoice for the recurring piece on a monthly basis. However, it did jump out a lot higher than we had expected, 52% growth year over year. What were the anomalies in that this quarter? Or were there any? Thanks.

Thanks, Greg. I think if you are talking about the growth in our deferred revenue balances on a year over year basis, I will point out that certainly our business is continue to grow. We've added a lot of new customers.

We've added a lot of new projects from those customers. We're obviously focusing tremendously now on marketplaces with a number of our customers. So typically as a result of all that activity, you would expect to see our deferred revenue balances grow from the professional services projects primarily that we've undertaken with the number of our customers, as I said.

All that being considered as well, another driver to the increase in deferred revenue, is if you recall we did change our customer relationship period and extended it to 10 years, which does also increase the deferred revenue balances. Now it is taking a longer period of time for us to bleed those deferred revenue balances off the balance sheet and onto the P&L as customers become live on our platform with projects that we've completed.

All right. Thank you, guys.

Thanks, Greg.

You next question comes from the line of Nandan Amladi from Deutsche Bank.

Good afternoon, Shawn and Milt. Congrats from my side as well on your first call as a public company. First question is kind of big picture. Shawn, maybe for you. How is the public discourse on healthcare reform, particularly since you went public, changed the tone of your conversations with both carriers and players?

Thanks, Nandan, we appreciate it. It really is an amazing time to be in employee benefits and the technology aspect of deploying great new technology, marketplace technologies for employers. And we all know that healthcare and that health insurance is such a big component of that.

So this level of awareness, really that's been taking place for a couple of years, this conversation, national conversation that we are having around the funding of healthcare, the buying and selling of health insurance, and the rules around that, and now we would refer to this as the first big October in a series of big Octobers that are coming. A lot of attention on these public exchanges, which we referred to in our comments that we really focus at Benefitfocus on private exchanges.

We are equipping private entities like insurance carriers and employers to prepare their own version of that. And so that, combined with the public offering of Benefitfocus, sort of the national stage that we are now on, and awareness has really created I think a fantastic conversation around the need for modern technology, the need to evolve the funding model, the economics of the benefits, and with the backdrop of just moving to the cloud, it couldn't be a better time to be having those conversations, both with our insurance carrier customers and also with our large employer customers.

Great, and a quick follow-up if I might. Carrier segment came in slightly ahead of what we were expecting, and of course your customer adds were pretty strong and you're deferred revenue jumped, as we just spoke about a moment ago. What were the dynamics of the two segments this quarter that brought this result, and what should we expect for the fourth quarter?

Sure. As Milton mentioned, Nandan, in the deferred revenues, a lot of big projects that we have coming through the pipe, and so we continue to see strong cells with our carrier business. Some of that increase in the deferred revenue was really milestone billings as we get these big projects ready for the fourth quarter, a lot of October 1 and fourth quarter go-lives in our carrier business.

And so as they approach -- as they move through the pipe you see additional increase in our deferred revenue from those milestones that we are accomplishing, and it is just super exciting to see the amount of activity and the projects that are moving through. That's probably the big dynamic there, is insurance carriers modernizing and being prepared for the new dynamics of the healthcare reform and the distribution and the move to defined-contribution.

The theme on the employer side is very similar. Large employers moving to the cloud is really the top aspect of our conversation that we are seeing in our strong customer adds in our large employer segment. And then of course they're in the middle of designing their benefits programs, really for 2014, but also for the next several years.

So we think that we represent just a fundamentally better way for them to manage those benefits. And those are the dynamics that we are seeing feeding in both business. How it feeds guidance, I will let Milt talk to that.

Yes. I mean, I think, Nandan, that your question's a good one. I think that we certainly, as Shawn pointed out, as some of these larger projects that we are working on now come to fruition and we bring these customers live, they'll obviously begin to show up on the top line as we recognize revenue from them. But clearly going forward, we still expect to close more and more deals, larger deals, and with these larger deals and these additional deals will come additional services projects, which obviously, as you know, based upon the way we account for the expenses, we will continue to recognize expense from new projects as we begin to finalize the ones that we are working on and they become revenue-generating in 2014.

Thank you.

Thank you.

Your next question comes from the line of Ross MacMillan with Jefferies.

Thanks a lot, and congratulations from me as well. Shawn, let's start with the comment you made on Mercer. I'm curious, it sounds like they've had a lot of success in this first year of building out, A, their platform with your help; and then, B, in recruiting quite a significant number of members to that platform. Can you just talk about that as an avenue of growth for the Company? Thanks.

Sure, absolutely. Thanks, Ross. We are super excited to be partnered with Mercer and providing the technology for the Mercer Marketplace. They did put out a press release a couple weeks ago announcing they had 33 great customers signed up to the Mercer Marketplace.

And so we just couldn't be more pleased with the aspects of a multi-carrier private exchange provided by such a leader in the industry of Mercer, and big names. One of the ones they named in the press release was Petco. They've got over 24,000 employees.

And the thing was ready on time, the marketplace launched on time. Customers are now using it, and just really a super success story. So we are real proud of that. I do want to give a shout-out to our software engineers and our product folks and our customer service and implementation team that have been working so hard on that particular implementation, and set-to-go-lives as well as across the board with all of our customers coming into the fourth quarter.

I think what it means, Ross, going forward is we've demonstrated our ability to scale a big cloud-based technology to handle large volumes of activity. And to me what it really means is we've got a real passion for product advancement, product leadership, and the marketplace is just such a key theme.

And being able to take the dynamics of an insurance carrier marketplace -- or insurance carrier market, large employer market and then add the capability to stand between them with someone like Mercer in a multi-carrier exchange for employers is just super exciting. So I think it goes back to the point earlier where we really feel like we are in the first inning of this awakening to a new and better way to manage benefits, to fund benefits, to communicate them. So obviously you can tell I'm passionate and proud of this one.

That's great, thank you. And maybe a follow-up for Milt. Milt, you mentioned that some timing on investments between Q3 and Q4, I think on a combined basis, you're going to do a little better than what you thought you would do in terms of adjusted EBITDA loss, or operating income loss. Is it all OpEx, or is there some of this related to more professional services, and therefore incrementally lower gross margin, just because of the accounting dynamic in the model? Just curious as to whether it's really just all an OpEx point or if there some of the other piece as well?

I think it is both, Ross. I think that we did ship some expenses out of the third quarter to the fourth quarter in some areas that will affect cost of revenue, primarily gearing up for our open enrollment season, which we are now in full swing on and bringing a record number of customers live as well as getting them enrolled during this period.

Also, I think when you look at some of our sales and marketing expenses we will, as we pointed out before, really now that the IPO is behind us and we've got our proceeds from the IPO, we will continue to make some accelerated investments now in the fourth quarter as we continue to grow out our sales and marketing team, primarily the sales team on the employer side of the business, and really make some investments that we think are going to allow us to continue to provide accelerating growth. As we pointed out with our guidance, with our results for the third quarter, as well as our guidance for the fourth quarter, we are still projecting, and have demonstrated, accelerating growth in the top line, and we need to make the investments in order to accomplish that.

Thank you very much.

Thanks, Ross.

Your next question comes from the line of Terry Tillman with Raymond James.

Good afternoon, and great job on the quarter.

Thanks, Terry.

First question. Shawn, just maybe you can just give us some education on the average customer size for the employer customer. I know 1000 employers is usually the starting point, but have you've been seeing any change even as recently as in third quarter in terms of the average size of a new employer customer? And then I had a follow-up to that.

Sure. I think I would say over the last couple years, Terry, the average size has drifted up modestly. We don't have necessarily a different strategy around what size target. We've identified in the US 18,000 -- roughly 18,000 large employers that have 1000 or more employees. And we've kind of dripping on that list and educating that group of employers for the last few years of Benefitfocus, our great technology. We obviously have increased our sales and marketing spend.

As our brand awareness has grown, as we've gotten more customers, now up to 379 large employers signed up. As you would expect, that kind of awareness grows, and I think this theme of defined-contribution and moving to the cloud is really of interest to larger and larger employers as well. So I would just say it sort of a natural, steady, and modest average size growth.

In any particular quarter it can move around a little bit, but it is been pretty consistent in the last couple years. Again, I would probably just, for practical purposes, emphasize that our strategy hasn't necessarily changed to go after mid ones or large ones or whatnot. We think that we provide a really great way for any employer in that size to move to the cloud and get a much better experience for their employees as they manage all their benefits in one place.

Got it, and on your website, and even some of these customers you announced, these are great brands. They tend to be, it seems like, I don't know 1 to 20,000 employee companies, more nimble, younger companies. What I'm curious about, mega-employers, is that not even kind of that actionable of a market at this point because maybe they just outsource a lot of things, or they're beholden to an ERP vendor? Could you maybe talk about that?

Yes, that's great. Maybe let's just go on 50,000 employees or more, or something in that range. I think because our investment in the employer, really the ramping in the employer sales and marketing has been over the last several years. A lot of those jumbo accounts, if you will, are with large outsourcing arrangements. Oftentimes their large outsourcing arrangement are multi-year, five or more years in length.

And so as our sales presence has grown, our number of interactions with those large accounts has grown. They take longer, they are actually more like our insurance carrier business in their size of deal and whatnot. I think you would just -- we sort of feel like it is natural for that cycle, for you to begin to see some of those larger names show up, I would say over the next few years.

Again, it doesn't -- our model doesn't require a jumbo account necessarily to make the whole thing work. There are so many. We have 379 out of 18,000. So it is such great work across that spectrum. But I think you are keying in on it where you think about the outsourcing arrangements. Now, we believe that as they go through those outsourcing renewals, they are going to need newer technology. They are going to want the latest technology. They are going to be thinking about the cloud and other areas of their business, and we would expect to see some real terrific opportunity over the next few years with all the dynamics on those jumbo accounts.

Got it. And I guess Milt, just real quick question on seasonality of new business signings. I think folks are probably going to hang their hat on what customers, or the number of new employer customers you add each quarter. Could you remind me and others in terms of what's the high season, if you will, for selling on the employer side? So just so we can kind of level set the expectations on the quarters that are going to be bigger for new employer signings? Thank you.

Sure, Terry. Yes, the seasonality, as we talked about before relative to our sales activity is that we really have focused in on about two-thirds of our selling activity occurs in the middle part of the year. And that's really what we've seen historically.

I will remind you, though, obviously that the employer business is relatively, in terms of the size of it to Benefitfocus is relatively new. So we are still analyzing seasonality. We are still analyzing those kind of metrics. But in general, I would say that the two-thirds in the middle two quarters of year is really kind of what we've seen so far.

And as you can imagine, Terry, with the healthcare reform and the implementation of the Affordable Care Act, that energy and that market is sort of just -- it is a lot of activity coming through the pipe there. And so I would say historical, the two-thirds in the middle part of the year. I think going forward, the signing of these and the time of their implementations, we wouldn't specifically run the business for our customer add, although I do agree with you, the reason we publish that number, because we think it is a nice important number to see.

But we don't specifically try and target a new logo add number. We more focused on that long-term building of that recurring revenue base.

Got it. Thanks, guys.

Thank you.

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

I would say good quarter, but we would get tazed at our office (laughter).

I read those musings today, Richard. Thanks.

Exactly. There's a guy standing over me right now. No, just a couple kind of technical questions. Is a Mercer-type plan, the private third-party exchanges, is that roughly priced kind of in between, on a per person basis, between carriers and employers? Is that kind of notionally where we should think that those things lay out?

Yes. I would say structurally it's similar to both. In other words, where subscription software is a service model which provides great visibility to our management team, but also to the customers. They have a really knowable cost on their side.

So the good thing about it is, it is of similar structure to both the employer and the carrier business. On the pricing side, I think I would say you're thinking about it correctly, although as you can imagine a deal of that magnitude and the way hopefully that it grows for them, there would be some features in there that will be dynamic over time as we add new capability and that kind of stuff.

I think you are probably in line with the way you are thinking about it. There's nothing structurally different about it.

And I have a question from an investor. He just asked, he said, was there anything baked in your numbers for healthcare reform, and if there's a potential push-out of the mandate on go-lives, does that have any effect? My answer was no, but I just wanted to double check.

Yes, that's actually a very thoughtful question, and I would answer it no. We are in a -- employers spend $1.6 trillion on benefits every year with or without healthcare reform. They're providing enormous -- 30% of compensation is on benefits.

And so the timing of new regulation, we go back to COBRA. The introduction of COBRA in the 1990s and HIPAA. So there's always something rolling through the system. This happens to be particularly large and public visibility on it is high.

But we really think the move to the cloud and the defined contribution is the bigger theme, with the added tailwind of the various aspects of the Affordable Care Act. I don't think it's -- we don't have something necessarily baked in one way or the other per quarter.

Perfect. Good. Thanks very much.

Super, thanks.

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

Under the premise that Obamacare takes the notion of the exchanges mainstream, I don't know if you agree with that would disagree with that, but do you foresee any problems in the public exchanges having any spillover affect into your business?

Yes. Thanks for the cowbell, Sean. It is near and dear to my heart here, our culture and our passion for what we're doing, and our customers. It is interesting. So we have -- if you think about the public exchanges, which they will work out whatever they are going to work out.

The key elements is getting individuals covered, providing coverage to folks who don't have it now, or might be in between employer-sponsored coverage, and then somehow getting their hands on this subsidy. That's the real power of the thing, is how do I get a subsidy to help offset my cost.

So what we -- we actually built in this notion that there would be a bit of a choppy rollout of the various state and federal exchanges for who knows what the reasons would have been. And so some of our insurance carriers that have the Benefitfocus private exchange now out in the market, or they're rolling it out in this fourth quarter, actually built in a feature whereby the carrier can -- is providing a private exchange direct to individuals. The individual can go on and shop, and when it comes time to apply for their subsidy, if for some reason there's a difficulty with the federal hub, the place where you get your subsidy, we wire into that.

We've actually built a collection engine where the insurance carrier can use a rep of their own, and pend that information, and then get it to the federal hub when it's available. And then contact the individual back. So it is actually almost created a service offering, if you will, and a way for insurance carriers to distinguish themselves as great service providers. So if there's some sort of frustration on the public side, come to our private exchange, get the great service that you would expect from us, and then we will work through the process with you.

And I think that's a really neat idea. So our technology is sort of enabling a service, if you will, there. There could be all kinds of other avenues to take that conversation, but that's just one example of how I actually think it kind of creates an opportunity for carriers in particular to provide a higher level of service, given the frustrations some people have had.

That's interesting. So you guys actually know how to electronically exchange benefits information pretty well. Not directly related to your business, but what is your opinion on what's going wrong at a detail level with some of the exchanges? And if they were to call you up and say, Shawn, we need you to come in and fix this, what's your recommendation?

There's a loaded question right there, Sean. Thanks for me putting me that one (laughter). As I sit here and observe what's happening with the exchanges. To me it just makes the point of how hard this is, and it has taken us 13 years to build the cloud-based technology that we have.

We exchange data with over 900 data exchange connections. It is a very tricky business. It is a difficult business, it is not something you do in a weekend, or even in nine months, as we now realize. It takes years and years.

I think one of the key aspects that I've seen in some of the articles and so forth is this idea that individuals are signing up, but all the information isn't totally being collected so that the insurance carrier can issue the coverage. And we would refer to that as business rules, data elements that need to be collected. We would call it a complete application, and that is, again that's just something that takes years and years of expertise, and mistakes quite frankly that we've made over those years, and gotten those things out of the way and built into our technology the ability to do that.

I think the other aspect is the relationship with the insurance carrier community, you have to be working with them. You have to have a, I would say a positive proactive relationship with these big systems that they have, with the people that they have inside their buildings, with the way they underwrite their programs, and rate their systems. State by state there's all these different rules.

So the list of things that makes this business hard is long. Those are just a few, and obviously I'm not really commenting. I'm not doing the work, so I'm not inside the rooms and what they are struggling with. I just know from doing it for years that it is a difficult business. It is hard to replicate.

One of the neat things that's happening, though, I think in our business is we have conversations with carriers through this period, and even employers. I think there's a whole new respect for how hard it is, and really I think even further sets Benefitfocus apart. A public offering, I don't think the timing could have been better, getting on the stage that we have with the capital that we now have, and in this conversation, particularly on the private side.

That's great. Appreciate your thoughts. Thank you very much.

Thanks.

Thank you. There are no further questions. I would now like to call back over to Mr. Shawn Jenkins, CEO, for any closing remarks.

Super. Thank you so much, everybody for joining us. It is a historic time for Benefitfocus. Our recent public offering, I couldn't be more proud of the management team, the software engineers, the folks that work so hard for our customers in such a busy time as the open enrollment season.

So I'm really proud of everybody, and I really appreciate all the folks that have joined us here today to hear our first earnings call, and very proud of our results. And thank you, Milt, for helping on the call today. I hope everyone has a great evening. Thank you very much.

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