BENEFITFOCUS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition
and results of operations together with our consolidated financial statements
and the related notes and other financial information included elsewhere in this
Annual Report on Form 10-K. Some of the information contained in this discussion
and analysis or set forth elsewhere in this report including information with
respect to our plans and strategy for our business, includes forward-looking
statements that involve risks and uncertainties. You should review the "Risk
Factors" section of this report beginning on page 19 for a discussion of
important factors that could cause actual results to differ materially from the
results described in or implied by the forward-looking statements contained in
the following discussion and analysis.
Overview
Benefitfocus provides a leading cloud-based benefits management platform for buyers (consumers, employees and employers) and sellers (insurance brokers, carriers and suppliers). The Benefitfocus Platform simplifies how organizations and individuals transact benefits. Our employer, carrier, broker and supplier customers rely on our platform to manage, scale and exchange benefits data seamlessly. Our solutions drive value for all participants in our benefits ecosystem. TheBenefitfocus platform has a multi-tenant architecture and a user-friendly interface designed for consumers to access all of their benefits in one place. Our comprehensive solutions support medical benefit plans and non-medical benefits, such as, dental, life, disability insurance, income protection, digital health and financial wellness. Our platform includes artificial intelligence functionality designed to help consumers identify and evaluate benefit options offered by their employer. As the number of employer benefits plans has increased, with each plan subject to many different business rules and requirements, demand for the Benefitfocus Platform is growing. In 2018, we expanded our economic model to include a transaction-oriented, buyer solution, known as BenefitsPlace, designed to align brokers, carriers and suppliers around the needs of employers, employees and consumers. In this model, our seller partners offer their voluntary and specialty benefit products through a holistic, multidimensional marketplace. This marketplace is designed to increase the economic value of the consumer lives on our platform by aligning the product catalog to consumer needs. In exchange forBenefitfocus delivering consumer access, data-driven analysis and operational efficiencies, seller partners pay us a percentage of the purchases completed on our platform. Carrier agreements have terms of two to four years and are typically cancellable upon breach of contract or insolvency. Supplier contracts have terms of one year or less and are generally cancellable upon breach of contract, failure to cure, bankruptcy and termination for convenience. 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. As a result of adding BenefitsPlace to our economic model in 2018, we now manage platform revenue as a separate stream. Accordingly, platform revenue is reported separately for the current and historical periods. Subscription revenue primarily consists of monthly subscription fees paid to us by our employer and insurance carrier 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 66%, 69%, and 72% of our total revenue during the years endedDecember 31, 2019 , 2018 and 2017, respectively. Platform revenue includes BenefitsPlace transactional revenue, which is generated from the value of the policies or products enrolled in through our marketplace. BenefitsPlace carrier revenue 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 BenefitsPlace 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 11%, 9%, and 6% of our total revenue during the years endedDecember 31, 2019 , 2018 and 2017, respectively. 50 -------------------------------------------------------------------------------- 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 23%, 22%, and 22% of our total revenue during the years endedDecember 31, 2019 , 2018 and 2017, respectively. Expanding our customer base is a key element of our growth strategy. We believe that our continued innovation and new solutions, such as BenefitsPlace, which extend the functionality of our mobile offerings, provide more robust data analytics capabilities and enhance our ability to quickly respond to evolving market needs with innovative capabilities will help us attract additional net benefit eligible lives to our platform through new employer customers, partners and brokers and increase our revenue from existing customers and relationships. We believe that there is a substantial market for our services, and we have been investing in growth over the past several years. In particular, we have continued to invest in technology and services to better serve our larger employer customers, which we believe are an important source of growth for our business. We have also substantially increased our marketing and sales efforts and expect those increased efforts to continue. As we have invested in growth, we have had operating losses in each of the last nine years, and expect our operating losses to continue for at least the next year. 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 substantially increased revenue, 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.
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 "Management's Discussion and Analysis of Financial Condition and Results of Operations-Components of Operating Results". In addition, we utilize other key metrics as described below.
Net Benefit Eligible Lives
We are focused on 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, growth and future revenue. We believe net benefit eligible lives is highly correlated to our subscription revenue and is the foundation of our platform revenue opportunity. During the third quarter of 2019, we added independent contractor lives, plus their estimated dependents, to our platform, for the first time. We believe these lives will drive incremental transaction revenue through the ability to participate in BenefitsPlace. Accordingly, because we signed our first contract with a "gig economy" company,Shipt, Inc. , which has a large workforce of freelancers, we have included these in our definition of net benefit eligible lives. We define a net benefit eligible life 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. As of December 31, 2019 2018 2017 (in millions) Net benefit eligible lives 17.3 13.3 11.2 InFebruary 2019 , we acquired certain operating assets and liabilities, intellectual property and intangible assets ofConnecture, Inc. This transaction added 2.0 million net benefit eligible lives to our platform. The details of this transaction are described in more detail in Note 3 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. 51 --------------------------------------------------------------------------------
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 active contracts 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, which represents combined
subscription and platform revenue, exceeded 95% for the years ended
Adjusted EBITDA Adjusted EBITDA represents our earnings before net interest and other expense, taxes, and depreciation and amortization expense, adjusted to eliminate stock-based compensation and impairment of goodwill and intangible assets, transaction and acquisition-related costs expensed, and costs not core to our business. Adjusted EBITDA is not a measure calculated in accordance withUnited States generally accepted accounting principles, or GAAP. Please refer to "Selected Consolidated Financial Data-Adjusted EBITDA" in this report for a discussion of the limitations of adjusted EBITDA and reconciliation of adjusted EBITDA to net loss, the most comparable GAAP measurement, respectively, for 2019, 2018 and 2017.
Components of Operating Results
Revenue
We derive the majority of our revenue from monthly subscription fees paid to us by our employer and carrier 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. Our professional 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):
Year Ended December 31,
2019 2018 2017
Subscription $ 195,091 $ 179,410 $ 169,593
Platform 33,654 22,938 15,298
Total software services $ 228,745 $ 202,348 $ 184,891
Professional services 66,941 56,373 51,951
Total revenue $ 295,686 $ 258,721 $ 236,842
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:
• Identification of each contract with a customer; • Identification of the performance obligations in the contract; • Determination of the transaction price;
• Allocation of the transaction price to the performance obligations in
the contract; and
• Recognition of revenue when, or as, performance obligations are satisfied.
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--------------------------------------------------------------------------------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 subscription service contracts are generally three years.
Subscription revenue also includes fees paid for other services, such as event sponsorships and certain data services.
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 BenefitsPlace 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 estimates for risk from premium collection, policy cancellation and termination.
Professional Services Revenue
Professional services revenue primarily consists of fees related to the implementation of software products purchased by customers. Professional services typically include discovery, configuration and deployment, integration, testing, and training. Fees from consulting services, support services and training are also included in professional services revenue.
We determined that implementation services for certain of our insurance carrier 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 insurance carrier customers are generally recognized over the contract term of the associated software services contract, including any extension periods representing a material right. We utilize estimates of hours as a measure of progress to determine revenue for certain types of arrangements.
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.
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
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services to our customers and supporting our SaaS 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,
professional fees, amortization expenses associated with acquired intangibles
and capitalized software development 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 expense over the estimate 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 plan to continue to expand our capacity to support our growth, which will
result in higher cost of revenue in absolute dollars. However, we expect cost of
revenue as a percentage of revenue to decline and gross margins to increase
primarily from the growth of the percentage of our revenue from large employers
and the realization of economies of scale driven by retention of our customer
base. However, this trend may vary on a quarterly basis.
Operating Expenses
Operating expenses consist of sales and marketing, research and development, and general and administrative expenses. Salaries and personnel-related costs are the most significant component of each of these expense categories. We expect to continue to hire new associates in these areas in order to support our anticipated revenue growth; however, we expect to decrease our operating expenses, as a percentage of revenue, if and as we achieve economies of scale. 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. For instance, our most significant promotional event isOne Place , which we hold annually. We expect our sales and marketing expense to increase, in absolute dollars, in the foreseeable future as we further expand our marketing activities in order to continue to grow our business. 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. 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 increase in absolute terms as a result of ongoing public company costs, including those associated with compliance with the Sarbanes-Oxley Act and other regulations governing public companies, increased costs of directors' and officers' liability insurance, and increased professional services expenses, particularly associated with the adoption of new accounting standards and integration of acquired businesses.
Other Income and Expense
Other income and expense consists primarily of interest income and expense and
gain (loss) on disposal of property and equipment. Interest income represents
interest received on our cash and cash
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equivalents. Interest expense consists primarily of the interest incurred on
outstanding convertible debt and borrowings under our lease arrangements and
credit facility.
Income Tax Expense
Income tax expense consists of U.S. federal and state income taxes. We incurred
minimal income tax expense for 2019, 2018, and 2017. Net operating loss
carryforwards for federal income tax purposes were approximately $327.4 million
at December 31, 2019 . State net operating loss carryforwards were approximately
$325.1 million at December 31, 2019 . Federal and state net operating loss
carryforwards will expire at various dates beginning in 2020, if not utilized.
Valuation allowances are recorded to reduce deferred tax assets to the amount we
believe is more likely than not to be realized.
Adoption of Leases Accounting Standard
We adopted the new accounting standard for Leases, Topic 842, onJanuary 1, 2019 . We applied the modified transition method at the beginning of adoption. Accordingly we did not adjust prior period financial statements, and recognized a cumulative-effect adjustment to the opening balance of accumulated deficit in 2019. The adoption of Topic 842 require lessees, among other things, to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous authoritative guidance. We describe the effects of adoption of Topic 842 in more detail in Note 2 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Results of Operations
Consolidated Statements of Operations Data
The following table sets forth our consolidated statements of operations data for each of the periods indicated (in thousands).
Year Ended December 31,
2019 2018 2017
Revenue $ 295,686 $ 258,721 $ 236,842
Cost of revenue(1) 144,090 129,277 127,382
Gross profit 151,596 129,444 109,460
Operating expenses:
Sales and marketing(1) 76,049 78,179 70,583
Research and development(1) 54,724 47,902 49,549
General and administrative(1) 45,329 43,062 27,268
Total operating expenses 176,102 169,143 147,400
Loss from operations (24,506 ) (39,699 ) (37,940 )
Other income (expense):
Interest income 2,613 250 182
Interest expense (23,524 ) (5,685 ) (4,931 )Interest expense on building lease
financing obligations (prior to adoption
of ASC 842) - (7,471 ) (7,450 ) Other expense (71 ) 6 (140 ) Total other expense, net (20,982 ) (12,900 ) (12,339 ) Loss before income taxes (45,488 ) (52,599 ) (50,279 ) Income tax expense 27 28 15 Net loss$ (45,515 ) $ (52,627 ) $ (50,294 )
(1) Cost of revenue and operating expenses include stock-based compensation
expense as follows (in thousands):
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Year Ended December 31,
2019 2018 2017
Cost of revenue $ 3,569 $ 5,164 $ 2,508
Sales and marketing 3,799 6,764 4,953
Research and development 3,265 5,510 2,990
General and administrative 8,939 11,430 5,686
The following table sets forth our consolidated statements of operations data as
a percentage of revenue for each of the periods indicated (as a percentage of
revenue).
Year Ended December 31,
2019 2018 2017
Revenue 100.0 % 100.0 % 100.0 %
Cost of revenue 48.7 50.0 53.8
Gross profit 51.3 50.0 46.2
Operating expenses:
Sales and marketing 25.7 30.2 29.8
Research and development 18.5 18.5 20.9
General and administrative 15.3 16.6 11.5
Total operating expenses 59.6 65.4 62.2
Loss from operations (8.3 ) (15.3 ) (16.0 )
Other income (expense):
Interest income 0.9 0.1 0.1
Interest expense (8.0 ) (2.2 ) (2.1 )
Interest expense on building lease financing
obligations (prior to adoption of ASC 842) - (2.9 ) (3.1 )
Other expense - - (0.1 )
Total other expense, net (7.1 ) (5.0 ) (5.2 )
Loss before income taxes (15.4 ) (20.3 ) (21.2 )
Income tax expense - - -
Net loss (15.4 ) % (20.3 ) % (21.2 ) %
Comparison of Years Ended
Revenue
Year Ended December 31,
2019 2018
Percentage of Percentage of Period-to-Period Change
Amount Revenue Amount Revenue Amount Percentage
(in thousands)
Subscription $ 195,091 66.0 % $ 179,410 69.3 % $ 15,681 8.7 %
Platform 33,654 11.4 22,938 8.9 10,716 46.7
Total software services $ 228,745 77.4 % $ 202,348 78.2 % $ 26,397 13.0 %
Professional services 66,941 22.6 56,373 21.8 10,568 18.7
Total revenue $ 295,686 100.0 % $ 258,721 100.0 % $ 36,965 14.3 %
Subscription revenue includes $11.1 million of revenue associated with assets
acquired from Connecture in February 2019 . Additionally, subscription revenue
increased $9.5 million from the net addition of new customers, contractual price
increases, and volume increases. These increases were offset by a $6.0 million
decrease in subscription revenue from the renegotiation of a customer contract
and decreases from customers that terminated products and services.
Additionally, sales allowance decreased resulting in an increase in subscription
revenue of $1.0 million .
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-------------------------------------------------------------------------------- Platform revenue increased from growth in premiums and new products from BenefitsPlace which resulted in an increase of$7.3 million in BenefitsPlace carrier revenue and an increase of$3.4 million in revenue from broker and supplier commissions. As discussed above in "Components of Operating Results - Revenue", platform revenue from carriers is recognized over the policy period and commissions revenue is recognized at a point in time. The increase in professional services revenue was primarily attributable to an increase of$12.5 million from work performed related to the customer contracts acquired fromConnecture inFebruary 2019 and a$1.3 million increase in customer support from new and existing customers. These increases were offset by a net decrease of$3.7 million from professional services work for customers in 2018 that did not recur in 2019. Professional services revenue increased as a percentage of total revenue in the current year compared to the prior year primarily as result of revenue from theConnecture acquisition. We expect this trend to end after the first quarter of 2020 when comparable periods will include the results of theConnecture operations for the full period. Cost of Revenue Year Ended December 31, 2019 2018 Percentage of Percentage of Period-to-Period Change Amount Revenue Amount Revenue Amount Percentage (in thousands) Cost of revenue$ 144,090 48.7 %$ 129,277 50.0 %$ 14,813 11.5 % The increase in cost of revenue in absolute terms was primarily attributable to an increase in salaries and other personnel-related costs of$8.0 million and increased depreciation expense of$4.1 million . The increase in salaries and personnel-related costs is primarily attributable to the workforce acquired fromConnecture inFebruary 2019 partially offset by decreases related to our cost structure in place prior to the acquisition. The increase in depreciation and amortization expense is attributable to the amortization of acquired intangibles from theConnecture acquisition as well as higher depreciation expense related to an increase in capitalized software development costs and the impact of the adoption of the new lease accounting standard at the beginning of 2019. Cost of revenue decreased as a percentage of revenue as we continued to achieve economies of scale. Cost of revenue included$3.6 million and$5.2 million of stock-based compensation expense for the years endedDecember 31, 2019 and 2018, respectively, and$16.0 million and$11.9 million of depreciation and amortization for the years endedDecember 30, 2019 and 2018, respectively. Gross Profit Year Ended December 31, 2019 2018 Percentage of Percentage of Period-to-Period Change Amount Revenue Amount Revenue Amount Percentage (in thousands) Software services$ 157,221 68.7 %$ 136,344 67.4 %$ 20,877 15.3 %
Professional services (5,625 ) (8.4 ) (6,900 )
(12.2 ) 1,275 (18.5 ) Gross profit$ 151,596 51.3 %$ 129,444 50.0 %$ 22,152 17.1 % The increase in software services gross profit was driven by a$26.4 million , or 13.0%, increase in revenue partially offset by a$5.5 million , or 8.4%, increase in software services cost of revenue. Software services cost of revenue included$2.1 million and$3.0 million of stock-based compensation expense for the years endedDecember 31, 2019 and 2018, respectively, and$12.8 million and$10.0 million of depreciation and amortization for the years endedDecember 31, 2019 and 2018, respectively. As discussed above, we are not able to meaningfully separate and assign costs of revenues to subscription and platform revenue separately. The improvement in professional services gross loss was driven by a$10.6 million , or 18.7%, increase in professional services revenue. This increase was partially offset by an increase in professional services cost of revenue of$9.3 million . Professional services cost of revenue included$1.5 million and$2.2 million of stock-based compensation expense for the years endedDecember 31, 2019 and 2018, respectively. In addition, professional services cost of revenue included$3.2 million and$1.9 million in depreciation and amortization for the years endedDecember 31, 2019 and 2018, respectively. 57 -------------------------------------------------------------------------------- Operating Expenses Year Ended December 31, 2019 2018 Percentage of Percentage of Period-to-Period Change Amount Revenue Amount Revenue Amount Percentage (in thousands) Sales and marketing$ 76,049 25.7 %$ 78,179 30.2 %$ (2,130 ) (2.7 ) % Research and development$ 54,724 18.5 %$ 47,902 18.5 %$ 6,822 14.2 % General and administrative$ 45,329 15.3 %$ 43,062 16.6 %$ 2,267 5.3 % The decrease in sales and marketing expense in absolute terms was primarily attributable to a decrease of$3.9 million in salaries and personnel-related costs and a decrease in travel-related costs of$0.3 million , partially offset by an increase of$1.4 million increase in the cost of marketing events that occurred during 2019 and IT-related costs. Salaries and personnel-related costs decreased primarily due to a decrease in number of sales associates that occurred starting in the second half of 2018. As a result we experienced lower salary expense and sales bonuses, as well as lower stock-based compensation. Stock-based compensation decreased primarily as a result of the forfeiture of stock awards related to the departure of employees who separated from the Company during the year. These decreases in salaries were partially offset by a decrease in the amount of commission expense capitalized in 2019 compared to 2018. As discussed above in "Components of Operating Results-Operating Expenses", certain sales commissions are capitalized and amortized over a period generally equal to four to five years. The increase in research and development expense is primarily attributable to costs related to the workforce acquired fromConnecture inFebruary 2019 . Additionally, depreciation and amortization and IT-related costs increased by$2.0 million . These increases were partially offset by an increase of$2.4 million in the amount of personnel-related costs capitalized for software development. The increase in general and administrative expense was primarily attributable to a net increase of$2.6 million in salary and personnel-related costs primarily as increases from investing in our business operations function were partly offset by a decrease in stock-based compensation of$2.5 million . Additionally, depreciation and amortization, IT-related expense, contract labor, travel-related and other operating expenses increased$2.3 million and insurance expense increased$0.2 million in connection with the acquisition of assets fromConnecture . These increases were partially offset by a decrease in professional and consulting costs of$2.8 million as implementation costs of the new lease accounting standard incurred in 2019 were more than offset by a decrease in professional fees associated with the adoption of the leasing and revenue accounting standards and internal control testing incurred during 2018.
Stock-based Compensation
Cost of revenue and operating expenses include an aggregate of$19.6 million and$28.9 million of stock-based compensation for the years endedDecember 31, 2019 and 2018, respectively, representing a decrease of$9.3 million , or a 32.2% decrease. The decrease is primarily attributable to expense from performance-based awards as the achievement of performance measures was lower for awards granted in 2019 compared to 2018. Additionally, expense decreased from the forfeitures of awards from employees who separated from the Company.
Comparison of Years Ended
Revenue
Year Ended December 31,
2018 2017
Percentage of Percentage of Period-to-Period Change
Amount Revenue Amount Revenue Amount Percentage
(in thousands)
Subscription $ 179,410 69.3 % $ 169,593 71.6 % $ 9,817 5.8 %
Platform 22,938 8.9 15,298 6.5 7,640 49.9
Total software services $ 202,348 78.2 % $ 184,891 78.1 % $ 17,457 9.4 %
Professional services 56,373 21.8 51,951 21.9 4,422 8.5
Total revenue $ 258,721 100.0 % $ 236,842 100.0 % $ 21,879 9.2 %
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-------------------------------------------------------------------------------- Growth in subscription revenue was primarily attributable to an increase of$9.2 million as a result of increases in net benefit eligible lives at existing customers (which we call volume increases), and also to existing customers purchasing additional products, as well as to the net addition of new customers. Subscription revenue included an increase of$1.1 million related to a change in estimated revenue from an employer customer contract. Platform revenue increased from growth in premiums and new products from BenefitsPlace which resulted in an increase of$4.4 million in BenefitsPlace carrier revenue and an increase of$3.2 million in revenue from broker and supplier commissions. As discussed above in "Components of Operating Results - Revenue", platform revenue from carriers is recognized over the policy period and commissions revenue is recognized at a point in time. The increase in professional services revenue was attributable to an increase in support revenue from newly activated customers of$2.2 million , an increase in customer-specific enhancements of$2.2 million , and an increase in implementation revenue of$1.9 million . These increases were partially offset by a reduction in non-recurring consulting revenue of$1.7 million . Cost of Revenue Year Ended December 31, 2018 2017 Percentage of Percentage of Period-to-Period Change Amount Revenue Amount Revenue Amount Percentage (in thousands) Cost of revenue$ 129,277 50.0 %$ 127,382 53.8 %$ 1,895 1.5 % The increase in cost of revenue in absolute terms was primarily attributable to an increase in salaries and personnel-related costs to support an increased number of customers and volume, as well as professional fees associated with third-party deliveries. This increase included an increase in stock-based compensation of$2.7 million . Cost of revenue as a percentage of revenue has continued to decrease as a result of economies of scale as our revenues have grown. Gross Profit Year Ended December 31, 2018 2017 Percentage of Percentage of Period-to-Period Change Amount Revenue Amount Revenue Amount Percentage (in thousands) Software services$ 136,344 67.4 %$ 121,879 65.9 %$ 14,465 11.9 %
Professional services (6,900 ) (12.2 ) (12,419 )
(23.9 ) 5,519 (44.4 ) Gross profit$ 129,444 50.0 %$ 109,460 46.2 %$ 19,984 18.3 % The increase in software services gross profit was driven by a$17.5 million , or 9.4%, increase in revenue partially offset by a$3.0 million , or 4.7%, increase in software services cost of revenue. Software services cost of revenue included$3.0 million and$1.3 million of stock-based compensation expense for the years endedDecember 31, 2019 and 2018, respectively, and$10.0 million and$9.6 million of depreciation and amortization for the years endedDecember 31, 2019 and 2018, respectively. As discussed above, we are not able to meaningfully separate and assign costs of revenue to subscription and platform revenue separately. The improvement in professional services gross loss was driven by a$4.4 million , or 8.5%, increase in professional services revenue and a decrease in professional services cost of revenue of$1.1 million . Professional services cost of revenue included$2.2 million and$1.2 million of stock-based compensation expense for the years endedDecember 31, 2019 and 2018, respectively. In addition, professional services cost of revenue included$1.9 million and$2.2 million in depreciation and amortization for the years endedDecember 31, 2019 and 2018, respectively. 59 -------------------------------------------------------------------------------- Operating Expenses Year Ended December 31, 2018 2017 Percentage of Percentage of Period-to-Period Change Amount Revenue Amount Revenue Amount Percentage (in thousands) Sales and marketing$ 78,179 30.2 %$ 70,583 29.8 %$ 7,596 10.8 % Research and development$ 47,902 18.5 %$ 49,549 20.9 %$ (1,647 ) (3.3 ) % General and administrative$ 43,062 16.6 %$ 27,268 11.5 %$ 15,794 57.9 % The increase in sales and marketing expense was primarily attributable to a$7.4 million increase in salaries and personnel-related costs due to hires of sales and marketing associates and higher variable compensation. As discussed above in "Components of Operating Results-Operating Expenses", certain sales commissions are capitalized and amortized over a period generally equal to four to five years. The decrease in research and development expense reflects continued cost efficiencies during 2018 as contracted services and professional fees decreased by$2.0 million . An additional decrease of$1.3 million is attributable to an increase in the amount of software development costs capitalized. These decreases were partially offset by an increase in salaries and personnel-related costs of$1.8 million primarily attributable to an increase in stock-based compensation. The increase in general and administrative expense included an increase in salary and personnel-related costs of$8.9 million , including an increase in stock-based compensation of$5.8 million . The remaining increase was primarily attributable to professional fees incurred in connection with implementing new accounting standards and costs associated with preparing for our first year of Sarbanes-Oxley 404(b) audit requirements, as well as transaction costs expensed, primarily in connection with a secondary stock offering during the second quarter of 2018.
Stock-based Compensation
Cost of revenue and operating expenses include an aggregate of$28.9 million and$16.1 million of stock-based compensation for the years endedDecember 31, 2018 and 2017, respectively, representing an increase of$12.8 million , or a 79.5% increase. The increase is primarily attributable to expense from performance-based awards granted in 2018 that are expected to vest.
Critical Accounting Policies and Significant Judgments and Estimates
Our management's discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses. In accordance with GAAP, we base our estimates on historical experience and on various other assumptions that we believe reasonable under the circumstances. Actual results might differ from these estimates under different assumptions or conditions. While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our consolidated financial statements.
Revenue Recognition and Deferred Revenue
We derive our revenue primarily from fees for subscription services and professional services sold to employers and insurance carriers as well as platform revenue derived from the value of products sold on our platform. Revenues are recognized 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. We also generate transactional revenue from the value of the policies or products enrolled through our marketplace.
We determine revenue recognition through the following steps:
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--------------------------------------------------------------------------------• Identification of each contract with a customer; • Identification of the performance obligations in the contract; • Determination of the transaction price;
• Allocation of the transaction price to the performance obligations in
the contract; and
• Recognition of revenue when, or as, performance obligations are satisfied.
The following are some significant judgments estimates involved in the recognition of revenue:
• Determination of standalone selling prices based on our overall
pricing objectives, taking into consideration market conditions and
other factors, including the value of our contracts, the software
services sold, customer size and complexity, and the number and types
of users under the contracts;
• Allocation of transaction price to the separate performance
obligations based on their relative standalone selling prices;
• Estimation of hours or lives as a measure of progress; and
• Reduction of revenue for risks from collectability, policy
cancellation and termination.
Convertible Senior Notes
To record their initial value in 2018, we calculated the fair value of the liability portion of the convertible senior notes using an implied interest rate. The rate was estimated based on market data available for publicly traded, senior unsecured corporate bonds issued by companies in the same industry and with similar maturity, assuming no conversion option. Assumptions used in the estimate represent what market participants would use in pricing the equity component, including market interest rates, credit standing, and yield curves.
Accounts Receivable and Allowances for Doubtful Accounts and Returns
We state accounts receivable at realizable value, net of an allowance for doubtful accounts and estimated returns. We maintain the allowance for doubtful accounts for estimated losses expected to result from the inability of some customers to make payments as they become due. We base our estimated allowance on our analysis of past due amounts and ongoing credit evaluations. Historically, our actual collection experience has not varied significantly from our estimates, due primarily to our credit and collection policies and the financial strength of our customers. The allowances for returns are accounted for as reductions of revenue and are estimated based on the Company's periodic assessment of historical experience and trends. The Company considers factors such as the time lag since the initiation of revenue recognition, historical reasons for adjustments, new customer volume, complexity of billing arrangements, timing of software availability, and past due customer billings.
Stock-Based Compensation
We currently issue restricted stock units under our stock plans. Stock-based awards granted to associates, directors, and non-associate third parties are measured at fair value at each grant date. We recognize stock-based compensation expense, net of forfeitures, ratably over the requisite service period of the option award. Restricted stock unit awards generally vest 25% on each anniversary of the grant date over 4 years, however we have granted awards that vest immediately as well as awards that vest annually over 3 years and 5 years. As part of our management incentive program, we granted performance restricted stock units, which have vesting terms that are dependent upon the achievement of certain financial performance targets. Compensation expense for performance restricted stock units, which are accounted for as equity awards, is recognized over the requisite service period when it is probable that the award will vest. Significant judgment is involved in assessing the probability of achieving performance measures. We determined fair value for restricted stock unit awards based on the closing price of our common stock on the date of grant or, if not a trading day, the trading day following the grant date. Based upon the closing stock price of$21.94 onDecember 31, 2019 , the aggregate intrinsic value of outstanding options to purchase shares of our common stock as ofDecember 31, 2019 was 61
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Liquidity and Capital Resources
Sources of Liquidity
As ofDecember 31, 2019 , our primary sources of liquidity were our cash and cash equivalents totaling$131.0 million ,$33.8 million in accounts receivables, net of allowance, and unused availability under our revolving line of credit then in effect of$88.5 million , without taking into account the borrowing base limit. The terms of that revolving line of credit are described in Note 9 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The revolving line of credit agreement expired onFebruary 20, 2020 . OnMarch 3, 2020 , we entered into a new revolving line of credit agreement withSilicon Valley Bank . The new agreement has a term of three years and a borrowing limit of$50.0 million with the ability to increase it to up to$100.0 million . The terms of the agreement are described in Item 9B. "Other Information." in this Annual Report on Form 10-K. InDecember 2018 , we issued$240.0 million aggregate principal amount of 1.25% convertible senior notes dueDecember 15, 2023 , unless earlier purchased by us or converted by the holder pursuant to their terms. Interest is payable semiannually in arrears onJune 15 andDecember 15 of each year. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination, at our election. The convertible senior notes have an initial conversion rate of 18.8076 shares of common stock per$1,000 principal amount. This represents an initial effective conversion price of approximately$53.17 per share of common stock, with an aggregate of 4,513,824 shares issuable upon conversion. The terms of the convertible senior notes are described in Note 8 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. In connection with our credit facility in effect atDecember 31, 2019 , we executed a loan and security agreement with a syndicate of lenders led bySilicon Valley Bank for a senior revolving credit agreement inFebruary 2015 . We are bound by customary affirmative and negative covenants in connection with that revolving line of credit, including financial covenants related to liquidity and EBITDA. In the event of a default, the lenders may declare all obligations immediately due and stop advancing money or extending credit under that line of credit. That line of credit is collateralized by substantially all of our tangible and intangible assets, including intellectual property and the equity of our subsidiaries. As ofDecember 31, 2019 , other than unused line fees which have all been paid, there was no outstanding indebtedness under that line of credit, which subsequently expired onFebruary 20, 2020 . Our cash flows from operations has improved in recent years and turned positive for the year endedDecember 31, 2018 . However, for the year endedDecember 31, 2019 , cash flows from operations declined due to timing in changes in working capital, a decrease in the balance of deferred revenue and the impact of acquired deferred revenue which yields revenue with no cash inflows. We expect to return to a trend of improving cash flows from operations in at least the near term as we continue to manage our costs. Based on our current level of operations and anticipated growth, we believe our future cash flows from operating activities and existing cash balances will be sufficient to meet our cash requirements for at least the next 12 months. Going forward, we may access capital markets to raise additional equity or debt financing for various business reasons, including required debt payments and acquisitions. The timing, term, size, and pricing of any such financing will depend on investor interest and market conditions, and there can be no assurance that we will be able to obtain any such financing on favorable terms or at all. 62 --------------------------------------------------------------------------------
Operating and Capital Expenditure Requirements
We believe that our existing cash and cash equivalents balances, cash generated from operations will be sufficient to meet our anticipated cash requirements through at least the next 12 months. Our future capital requirements will depend on many factors, including our customer growth rate, subscription renewal activity, the timing and extent of development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced services offerings, and the continuing market acceptance of our services. We might require additional capital beyond our currently anticipated amounts. If our available cash and cash equivalents balances are insufficient to satisfy our liquidity requirements, we may seek to sell equity or convertible debt securities or enter into an additional credit facility. The sale of equity and convertible debt securities may result in dilution to our stockholders and those securities may have rights senior to those of our common shares. If we raise additional funds through the issuance of convertible debt securities, these securities could contain covenants that would restrict our operations. Additional capital might not be available on reasonable terms, or at all.
Contractual Obligations and Commitments
Our principal commitments consist of obligations under our credit facility in effect atDecember 31, 2019 , non-cancelable leases for our office space and computer equipment and purchase commitments for our co-location and other support services. The following table summarizes these contractual obligations atDecember 31, 2019 . Future events could cause actual payments to differ from these estimates. Payment due by period Less than 1 More than 5
Contractual Obligations Total year 1-3 years 3-5 years years
(in thousands)
Long-term debt--Convertible
senior notes $ 240,000 $ - $ - $ 240,000 $ -
Long-term debt--Revolving line
of
credit (1) - - - - -
Operating lease obligations 2,279 445 776 573 485
Financing lease obligations 153,847 13,474 25,160 23,249 91,964
Financing obligations, other 2,089 1,329 693 67 -
Purchase commitments 2,067 1,370 697 - -
Total $ 400,282 $ 16,618 $ 27,326 $ 263,889 $ 92,449
(1) Repayment of the revolving line of credit is due at end of the term in
February 2020 . Early repayment is allowed. Interest is paid monthly.
In December 2018 , we issued $240.0 million of convertible senior notes that pay
interest at 1.25% and mature December 2023 . The terms of the notes are disclosed
in more detail in Note 2 of our consolidated financial statements included
elsewhere in this Annual Report on Form 10-K.
Borrowing limit under our revolving line of credit agreement in effect of
December 31, 2019 is $95.0 million . Borrowing capacity under that agreement is
subject to a borrowing base limit that is a function of our monthly recurring
revenue as adjusted to reflect lost customer revenue during the previous three
calendar months. Therefore, credit available under that line of credit may be
less than the $95.0 million borrowing limit. Advances under that line of credit
bear interest at the prime rate as published in the Wall Street Journal plus a
margin based on the Company's liquidity that ranges between 0.75% and 1.25%. The
Company is charged an unused line fee under this arrangement at a rate based on
its liquidity of 0.300% to 0.375% per year. Any outstanding principal is due at
the end of the term. Available credit was $88.5 million as of December 31, 2019 .
The revolving line of credit agreement expired on February 20, 2020 .
On March 3, 2020 , we entered into a new revolving line of credit agreement with
Silicon Valley Bank . The agreement has a term of three years and a borrowing
limit of $50.0 million with the ability to increase it to up to $100.0
million . The terms of the agreement are described in Item 9B. "Other
Information." in this Annual Report on Form 10-K.
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In
Off-Balance Sheet Arrangements
As ofDecember 31, 2019 , other than as disclosed in Note 8 and 17, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) ofSEC Regulation S-K, such as the use of unconsolidated subsidiaries, structured finance, or special purpose entities. We are not the primary beneficiary of, nor do we have a controlling financial interest in, any variable interest entity. Accordingly, we have not consolidated any variable interest entities.
Recent Accounting Pronouncements
InJune 2016 , the FASB ASU No. 2016-13, "Measurement of Credit Losses on Financial Instruments." The purpose of this ASU is to require a financial asset measured at amortized cost basis to be presented at the net amount expected to be collected. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. This ASU is effective for interim and annual reporting periods beginning afterDecember 15, 2019 . We expect our net accounts receivable to be impacted by the adoption of this guidance but we have not completed quantifying its impact on our financial statements. We are evaluating other accounting standards and exposure drafts that have been issued or proposed by the FASB or other standards setting bodies that do not require adoption until a future date to determine whether adoption will have a material impact on our consolidated financial statements.
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