BENEFITFOCUS, INC. The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes appearing elsewhere in this Quarterly Report on
Form 10-Q and with the financial statements, related notes and Management's
Discussion and Analysis of Financial Condition and Results of Operations in our
Annual Report on Form 10-K, as amended for the fiscal year ended
Overview
Our economic model includes a transaction-oriented solution, known as our
Benefit Catalog, that aligns brokers, carriers and suppliers around the needs of
employers and employees. In this model, Benefit Catalog sellers, who are
carriers and suppliers, offer their voluntary and specialty benefit products in
a "marketplace" alongside the benefits enrollment platform. This marketplace is
designed to increase the economic value of the employee and consumer lives on
our platform by aligning Benefit Catalog products to consumer needs. In exchange
for
We classify our revenue into three streams - subscription, platform, and professional services revenue. Subscription and platform revenue are combined and reported as software services revenue.
Subscription revenue primarily consists of monthly subscription fees paid to us
by our employer and health plan customers for access to, and usage of,
cloud-based benefits software solutions for a specified contract term.
Subscription fees are generally charged based on the number of employees or
subscribers with access to the solution. Subscription revenue accounted for
approximately 73% and 72% of our total revenue during the three-month period
ended
Platform revenue includes Benefit Catalog transactional revenue, which is
generated from the value of the policies or products enrolled in through our
marketplace. Benefit Catalog revenue from insured products is generally
recognized over the policy period of the enrolled products. In arrangements
where we sell policies to employees of our customers as the broker, we earn
insurance broker commissions. Revenue from insurance broker commissions and
Benefit Catalog supplier transactions is generally recognized at the time when
open enrollment is complete and the orders for policies are transferred to the
supplier. Platform revenue accounted for approximately 10% of our total revenue
during each of the three-month periods ended
Our professional services revenue stream is largely derived from the
implementation of our customers onto our platform, which typically includes
discovery, configuration and deployment, integration, testing, and training. We
also provide customer support services and customized media content that
supports our customers' effort to educate and communicate with consumers.
Professional services revenue accounted for approximately 17% and 18% of our
total revenue during the three-month period ended
We believe there is a substantial addressable market for our products and services, and we have been investing to further enhance and expand our products over the past several years. We believe that our continued innovation and solutions, which extend the functionality of our offerings, provide more robust data analytics capabilities and enhance our ability to quickly respond to evolving market needs. We believe these innovative capabilities, as well as strong customer service, will help us attract and retain new customers, partners and brokers and increase our revenue from existing customers and relationships. Through our considerable domain expertise, a best-in-class experience, as well as continued innovation on our platform, we believe we will drive better customer retention. We are committed to strengthening our core, growing with intent and increasing our operational efficiencies to deliver exceptional value to our customers and shareholders.
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As we have invested in growth, we have had operating losses in each of the last eleven years. Although our operating results have improved, we could incur operating losses in future periods. Due to the nature of our customer relationships, which have been stable in spite of some customer losses over the past years, and our hybrid subscription and transaction-based financial model, we believe that our current investment in growth should lead to increased revenue in the long-term, which may allow us to achieve profitability in the relatively near future. Of course, our ability to achieve profitability will continue to be subject to many factors beyond our control.
The primary impact of the COVID-19 pandemic on our business and financial
results were longer sales cycles and slowdown in new sales activity in 2020 and
2021, which negatively impacted growth in subscription revenue and platform
revenue from new business which is impacting our topline revenue in 2022. While
demand from our health plan customers has not returned to pre-pandemic levels,
noting health plan administrators redirected focus and resources to competing
priorities, we are beginning to see a return in demand from our health plan
customers. The trailing impacts of the pandemic on the broader
However, as a result of the nature of our customer relationships, the stability of our subscription revenue, the cost restructuring actions taken and our ongoing investments in automation and process improvements, we believe we will continue to generate cash flows from operations on an annual basis although there will be fluctuations from quarter to quarter. Of course, our ability to generate cash flows from operations is subject to many risks and factors beyond our control.
Recent Developments
On
Key Financial and Operating Performance Metrics
We regularly monitor a number of financial and operating metrics in order to measure our current performance and project our future performance. These metrics help us develop and refine our growth strategies and make strategic decisions. We discuss revenue, gross margin, and the components of operating loss in "Components of Operating Results" below. In addition, we utilize other key metrics as described below.
Adjusted EBITDA
Adjusted EBITDA represents our losses before net interest, taxes, and depreciation and amortization expense, adjusted to eliminate stock-based compensation; transaction and acquisition-related costs expensed; restructuring costs; impairment of goodwill, intangible assets and long-lived assets; gain or loss on extinguishment of debt; other costs not core to our business; loss on settlement of lawsuits; and, changes in fair value of contingently returnable consideration. Please note that other companies might define their non-GAAP financial measures differently than we do.
We have included adjusted EBITDA in this report because it is a key measure used by our management and Board of Directors to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, and to develop short- and long-term operational plans. In particular, we believe that the exclusion of the expenses eliminated in calculating adjusted EBITDA can provide a useful measure for period-to-period comparisons of our core business. Accordingly, we believe that adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results.
However, adjusted EBITDA is not a measure calculated in accordance with
•
although depreciation and amortization are non-cash charges, the assets being depreciated and amortized might have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
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adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
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adjusted EBITDA does not reflect the potentially dilutive impact of stock-based compensation;
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adjusted EBITDA eliminates expenses, such as transaction and acquisition-related costs expensed, restructuring costs, impairment charges, and other costs not core to our business, that might nonetheless recur;
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•
adjusted EBITDA does not reflect interest or tax or dividend payments that would reduce the cash available to us; and
•
other companies, including companies in our industry, might calculate adjusted EBITDA or similarly titled measures differently, which reduces their usefulness as comparative measures.
Because of these and other limitations, you should consider adjusted EBITDA alongside other GAAP-based financial performance measures, including various cash flow metrics, gross profit, net loss and our other GAAP financial results. The following table presents for each of the periods indicated a reconciliation of adjusted EBITDA to the most directly comparable GAAP financial measure, net loss (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
Reconciliation from Net Loss to Adjusted
EBITDA:
Net loss $ (6,986 ) $ (18,054 ) $ (21,427 ) $ (35,171 )
Depreciation 2,958 3,615 9,456 10,682
Amortization of software development
costs 2,462 2,268 7,280 6,589
Amortization of acquired intangible
assets 1,073 568 3,219 1,705
Interest income (223 ) (52 ) (307 ) (163 )
Interest expense 2,918 5,556 7,876 16,757
Income tax expense 49 42 94 125
Stock-based compensation expense 4,218 4,595 10,722 10,494
Transaction and acquisition-related
costs expensed 19 80 115 240
Impairment of lease right-of-use assets - - 1,769 4,003
Change in fair value of contingently
returnable consideration - - (719 ) -
Restructuring costs - - 1,006 4,127
(Gain) loss on repurchase of convertible
senior notes (1,930 ) 7,520 (1,930 ) 7,520
Costs not core to our business 1,171 542 5,926 4,140
Total net adjustments 12,715 24,734 44,507 66,219
Adjusted EBITDA $ 5,729 $ 6,680 $ 23,080 $ 31,048 Software Services Revenue Retention Rate
We believe that our ability to retain our customers and expand the revenue they generate for us over time is an important component of our growth strategy and reflects the long-term value of our customer relationships. We measure our performance on this basis using a metric we refer to as our software services revenue retention rate. We calculate this metric for a particular period by establishing the group of our customers that had revenue for a given period. We then calculate our software services revenue retention rate by taking the amount of software services revenue we recognized for this group in the subsequent comparable period (for which we are reporting the rate) and dividing it by the software services revenue we recognized for the group in the prior period.
Our software services revenue retention rate was approximately 88% and 90% for
the three- and nine-month periods ended
Contracted Annual Recurring Revenue
Contracted Annual Recurring Revenue ("ARR") is an indicator of the future
trajectory of our recurring revenue. We define Contracted ARR as the annual
recurring revenue value under contract with our customers. This is typically the
per member or employee recurring fee for use of our products to both Employer
and Health Plans and the subscription fees for recurring Professional Services
such as our call center. ARR from new customer contracts are included at the
time of execution of the contract and ARR from terminated customers are deducted
at the time of contract termination. The decline in Contracted ARR at
As of September 30,
2022 2021
(in millions)
Contracted Annual Recurring Revenue 198.8 213.9
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Net Benefit Eligible Lives
Part of our growth strategy is to expand our customer base. This includes driving revenue growth from adding lives to our platform and driving incremental transaction revenue. We believe the number of net benefit eligible lives is a key indicator of our market penetration and future revenue opportunity. We define a net benefit eligible life as a person with access to a benefits enrollment subscription under standard contracting or a freelancer with access to benefits enrollment, plus their estimated dependents, as of the measurement date. This definition excludes lives from other subscription-related contracts.
The decrease in net benefit eligible lives at
As of September 30,
2022 2021
(in millions)
Net benefit eligible lives 15.1 16.0
Components of Operating Results
Revenue
We derive the majority of our revenue from monthly subscription fees paid to us by our employer and health plan customers for access to, and usage of, our cloud-based benefits software solutions for a specified contract term. We derive platform revenue from both insurance broker commissions from the sale of voluntary and ancillary benefits policies to employees of our customers and from transaction revenue from life and ancillary insurance carriers and specialty providers. We also derive revenue from professional services fees, which primarily include fees related to the implementation of our customers onto our platform and delivery of our call center services. Our implementation services typically include discovery, configuration and deployment, integration, testing, and training.
The following table sets forth a breakdown of our revenue by stream for the periods indicated (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
Subscription $ 41,248 $ 44,790 $ 126,320 $ 134,716
Platform 5,643 6,157 18,786 19,801
Total software services $ 46,891 $ 50,947 $ 145,106 $ 154,517
Professional services 9,299 11,079 28,896 33,476
Total revenue $ 56,190 $ 62,026 $ 174,002 $ 187,993 We recognize revenue when control of these services is transferred to customers in an amount that reflects the consideration we expect to be entitled to in exchange for those services. Taxes collected from customers relating to services and remitted to governmental authorities are excluded from revenues.
We determine revenue recognition through the following steps:
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Identification of each contract with a customer;
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Identification of the performance obligations in the contract;
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Determination of the transaction price;
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Allocation of the transaction price to the performance obligations in the contract; and
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Recognition of revenue when, or as, performance obligations are satisfied.
Software Services Revenue
Software services revenue consists of subscription and platform revenue.
Subscription Revenue
Subscription revenue primarily consists of monthly subscription fees paid to us by our customers for access to, and usage of, cloud-based benefits software solutions for a specified contract term. Fees are generally charged based on the number of employees or subscribers with access to the solution.
Subscription revenue is generally recognized on a ratable basis over the contract term beginning on the date the subscription services are made available to the customer. Our initial subscription service contracts are generally three years.
Subscription revenue also includes fees paid for other services, such as event sponsorships and certain data services.
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Platform Revenue
Platform revenue is generated from the value of the policies or products enrolled in through our marketplace. Platform revenue from carriers is generally recognized over the policy period of the enrolled products. In arrangements where we sell policies to employees of our customers as the broker, we earn insurance broker commissions. Revenue from insurance broker commissions and Benefit Catalog supplier transactions is recognized at the point when the orders for the policies are received and transferred to the insurance carrier or supplier and is reduced by constraints for variable consideration associated with collectability, policy cancellation and termination risks.
Professional Services Revenues
Professional services revenue primarily consists of fees related to the implementation of software products purchased by customers. Implementation services typically include discovery, configuration and deployment, integration, testing, and training. Fees from consulting services, call center services, support services and training are also included in professional services revenue.
We determined that implementation services for certain of our health plan customers significantly modify or customize the software solution and, as such, do not represent a distinct performance obligation. Accordingly, revenue from such implementation services with these health plan customers are generally recognized over the contract term of the associated software services contract, including any extension periods representing a material right.
Revenue from implementation services with employer customers is generally recognized as those services are performed.
Revenue from support and training fees is recognized over the service contract period.
We utilize estimates of hours as a measure of progress to determine revenue for certain types of arrangements.
Contracts with Multiple Performance Obligations
Certain of our contracts with customers contain multiple performance obligations. For these contracts, the individual performance obligations are accounted for separately if they are distinct. The transaction price is allocated to the separate performance obligations based on their relative standalone selling prices. We determine the standalone selling prices based on their overall pricing objectives, taking into consideration market conditions and other factors, including the value of their contracts, the software services sold, customer size and complexity, and the number and types of users within the contracts.
Overhead Allocation
Expenses associated with our facilities, security, information technology, and depreciation and amortization, are allocated between cost of revenue and operating expenses based on employee headcount determined by the nature of work performed.
Cost of Revenue
Cost of revenue primarily consists of salaries and other personnel-related costs, including benefits, bonuses, and stock-based compensation, for employees, whom we refer to as associates, providing services to our customers and supporting our software platform infrastructure. Additional expenses in cost of revenue include co-location facility costs for our data centers, depreciation expense for computer equipment directly associated with generating revenue, infrastructure maintenance costs, contract labor, professional fees, amortization expenses associated with acquired intangibles and capitalized internally developed software costs, allocated overhead, and other direct costs.
We expense cost of revenue associated with fulfilling performance obligations as we incur the costs. Costs that relate directly to a customer contract that are not related to satisfying a performance obligation are capitalized and amortized to cost of revenue over the estimated period of benefit of the contract asset, which is generally five years.
Subscription and platform revenue are both generated from our platform and result from the same set of assets and activities. As such, we are not able to meaningfully separate and assign costs of revenue to subscription and platform revenue separately.
We expect cost of revenue as a percentage of revenue to decline and gross margins to increase as we realize the full impact of our restructuring activities and increased automation. However, this trend may vary on a quarterly basis.
Operating Expenses
Operating expenses consist of sales and marketing, research and development, general and administrative, and restructuring expenses. Salaries and personnel-related costs are the most significant component of each of these expense categories. We expect our operating expenses as a percentage of revenue for 2022 to be near levels realized for 2021. As we continue to invest in our product offerings and see the impacts going forward of our rationalization decisions that we have put in place, we expect to see an overall improvement in our operating expense.
Sales and marketing expense. Sales and marketing expense consists primarily of salaries and other personnel-related costs, including benefits, bonuses, stock-based compensation and commissions, for our sales and marketing associates. Costs to obtain a contract that are incremental, such as sales commissions, are capitalized and amortized to expense over the estimated period of benefit of the asset, which is generally four to five years. Additional expenses include advertising, lead generation, promotional event programs, corporate communications, travel, and allocated overhead.
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Research and development expense. Research and development expense consists primarily of salaries and other personnel-related costs, including benefits, bonuses and stock-based compensation, for our research and development associates. Additional expenses include costs related to the development, quality assurance, and testing of new technology, and enhancement of our existing platform technology, consulting, travel, and allocated overhead. We believe continuing to invest in research and development efforts is essential to maintaining our competitive position. We are investing in transforming our development philosophy and practices to that of an agile development organization. We have increased the frequency of new product releases to monthly from quarterly to deliver customer value every month consistently throughout the year. We believe this will allow us to more quickly innovate and adapt to changing market conditions and customer needs.
General and administrative expense. General and administrative expense consists primarily of salaries and other personnel-related costs, including benefits, bonuses, and stock-based compensation for administrative, finance and accounting, information systems, legal, and human resource associates. Additional expenses include consulting and professional fees, insurance and other corporate expenses, and travel. We expect our general and administrative expenses to be flat to down despite continued professional services expenses in connection with activist shareholder matters.
Impairment of lease right-of-use assets. Impairment of lease right-of-use assets
consists of adjustments to the asset value created by the difference in
discounted cash inflows and outflows as described in Note 11 to the financial
statements included in this report. During the nine months ended
Change in fair value of contingently returnable consideration. Change in fair
value of contingently returnable consideration consists of adjustments for
assets measured at fair value on a recurring basis using significant
unobservable inputs, adjusted for management expectations as the time to settle
becomes realizable, as described in Note 5 to the financial statements included
in this report. During the three- and nine-month periods ended
Restructuring costs. Restructuring costs are comprised of one-time severance
charges, continuation of health benefits and outplacement services. During the
nine months ended
Other Income and Expense
Other income and expense consists primarily of interest income and expense, sublease income and gain (loss) on disposal of property and equipment. Interest income represents interest received on our cash and cash equivalents. Interest expense consists of the interest incurred on outstanding convertible debt and lease arrangements.
Income Tax Expense
Income tax expense consists of
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