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As filed with the Securities and Exchange Commission August 14, 2013

Registration No. 333-            

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Benefitfocus, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

(State or other jurisdiction of
incorporation or organization)

 

7372

(Primary Standard Industrial
Classification Code Number)

 

46-2346314

(I.R.S. Employer
Identification Number)

100 Benefitfocus Way

Charleston, SC 29492

(843) 849-7476

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Paris Cavic, Esq.

General Counsel

100 Benefitfocus Way

Charleston, SC 29492

(843) 849-7476

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Donald R. Reynolds, Esq.

S. Halle Vakani, Esq.

David P. Creekman, Esq.

Wyrick Robbins Yates & Ponton LLP

4101 Lake Boone Trail, Suite 300

Raleigh, NC 27607

(919) 781-4000

 

Christopher J. Austin, Esq.

Goodwin Procter LLP

Exchange Place

53 State Street

Boston, MA 02109

(617) 570-1000

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box.     ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.     ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.     ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.     ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer     ¨      Accelerated filer      ¨    Non-accelerated filer     x   Smaller reporting company      ¨
        (Do not check if a smaller reporting company)  

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each Class of

Security being registered

 

Proposed

Maximum

Aggregate Offering
Price(1)

 

Amount of

Registration Fee(2)

Common Stock, $0.001 par value per share

  $75,000,000   $10,230

 

 

(1) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended, and includes shares of common stock that the underwriters have an option to purchase.
(2) Calculated pursuant to Rule 457(o) based on an estimate of the proposed maximum aggregate offering price.

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated August 14, 2013

            Shares

 

LOGO

Common Stock

 

 

This is an initial public offering of shares of common stock of Benefitfocus, Inc.

Benefitfocus is offering             of the shares to be sold in the offering. The selling stockholders identified in the prospectus are offering             shares. Benefitfocus will not receive any of the proceeds from the sale of the shares being sold by the selling stockholders.

Prior to this offering, there has been no public market for our common stock. It is currently estimated that the initial public offering price per share will be between $         and $         . We intend to apply to list our common stock on the NASDAQ Stock Market under the symbol “BNFT”. Upon completion of this offering, we will be a “controlled company” as defined under the NASDAQ Stock Market listing rules.

We are an “emerging growth company” under the federal securities laws and are eligible for reduced public company reporting requirements. Investing in our common stock involves a high degree of risk. See “ Risk Factors ” beginning on page 12.

 

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total  

Initial public offering price

   $                    $                

Underwriting discount(1)

   $         $     

Proceeds, before expenses, to Benefitfocus

   $         $     

Proceeds, before expenses, to the selling stockholders

   $         $     

 

(1) The underwriters will receive compensation in addition to the underwriting discount. See “Underwriting (Conflicts of Interest)” on page 138 of this prospectus for a description of the compensation payable to underwriters.

To the extent that the underwriters sell more than             shares of common stock, the underwriters have the option to purchase up to an additional             shares from Benefitfocus and up to an additional shares from the selling stockholders at the initial public offering price less the underwriting discount.

 

 

The underwriters expect to deliver the shares against payment in New York, New York on                     , 2013.

 

Goldman, Sachs & Co.   Deutsche Bank Securities   Jefferies

 

 

 

Canaccord Genuity    Piper Jaffray    Raymond James

Prospectus dated                     , 2013.


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LOGO


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LOGO

FOUNDED 2000 HEADQUARTERS Charleston, SC OFFICES Greenville, SC Tulsa, OK San Francisco, CA PORTFOLIO OF PRODUCTS HR InTouch eEnrollment eBilling eExchange eSales eDirect Marketplace Benefit Informatics Media & Animation All Your Benefits. One Place.” The Benefitfocus platform provides an integrated suite of solutions that enables our customers (employers and insurance carriers) to more efficiently shop, enroll, manage, and exchange benefits information. More than 20 million insured individuals and their dependents (our consumers or members) manage all types of benefits on the Benefitfocus platform. Consumers on the Benefitfocus Platform Dec Dec Dec Dec Dec Dec Apr 07 08 09 10 11 12 13 The Benefitfocus portfolio of products supports every phase of the benefits lifecycle: Data analysis plan design and insurance carrier selection open enrollment planning and communication open enrollment (shop & enroll) ongoing maintenance (manage & exchange)billing management claims utilization and expense Dec 07 dec 08 dec 09 dec 10 dec 11 dec 12 apr 13 20+ million


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LOGO


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TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     12   

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     38   

INDUSTRY AND MARKET DATA

     38   

USE OF PROCEEDS

     40   

DIVIDEND POLICY

     40   

CAPITALIZATION

     41   

DILUTION

     43   

CONSOLIDATED SELECTED FINANCIAL DATA

     45   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     49   

BUSINESS

     87   

MANAGEMENT

     106   

EXECUTIVE COMPENSATION

     114   

CERTAIN RELATIONSHIPS AND RELATED-PARTY TRANSACTIONS

     124   

PRINCIPAL AND SELLING STOCKHOLDERS

     130   

DESCRIPTION OF CAPITAL STOCK

     133   

SHARES ELIGIBLE FOR FUTURE SALE

     137   

CERTAIN U.S. FEDERAL TAX CONSIDERATIONS APPLICABLE TO NON-U.S. HOLDERS

     140   

UNDERWRITING (CONFLICTS OF INTEREST)

     144   

LEGAL MATTERS

     149   

EXPERTS

     149   

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     150   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

 

 

You should rely only on the information contained in this document and any free-writing prospectus we provide to you. We have not authorized anyone to provide you with information that is different. We are not making offers to sell or soliciting offers to buy in any jurisdiction where the offer or sale is not permitted. You should assume the information in this document is accurate on the date of this document only. Our business, financial condition, results of operations and prospects may have changed since that date.


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PROSPECTUS SUMMARY

This summary highlights information appearing elsewhere in this prospectus. You should read the following summary together with the more detailed information appearing in this prospectus, including our financial statements and related notes, and the risk factors beginning on page 12, before deciding whether to purchase shares of our common stock. Unless the context otherwise requires, we use the terms “Benefitfocus,” “the Company,” “our company,” “we,” “us,” and “our” in this prospectus to refer to the consolidated operations of Benefitfocus, Inc. and its consolidated subsidiaries as a whole.

Benefitfocus, Inc.

Overview

Benefitfocus is a leading provider of cloud-based benefits software solutions for consumers, employers, insurance carriers, and brokers. The Benefitfocus platform provides an integrated suite of solutions that enables our customers (which are employers and insurance carriers) to more efficiently shop, enroll, manage, and exchange benefits information. Our web-based platform has a user-friendly interface designed to enable insured individuals and their dependents (which we refer to as consumers or members) to access all of their benefits in one place. Our comprehensive solutions support core benefits plans, including healthcare, dental, life, and disability insurance, and voluntary benefits plans, such as critical illness, supplemental income, and wellness programs. 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 has grown.

The Benefitfocus platform enables our customers to simplify the management of complex benefits processes, from sales through enrollment and implementation to ongoing administration. It provides consumers with an engaging, highly intuitive, and personalized user interface for selecting and managing all of their benefits via the web or mobile devices. Employers use our solutions to streamline benefits processes, keep up with complex regulatory requirements, control costs, and offer a greater variety of plans to attract, retain, and motivate their employees. Insurance carriers use our solutions to more effectively market offerings, manage billing, and improve the enrollment process. We also provide a network of over 900 benefit provider data exchange connections, which facilitates the otherwise highly fragmented interaction among employees, employers, and carriers.

We serve two separate but related market segments. Our fastest growing market segment, the employer market, consists of employers offering benefits to their employees. Within this segment, we mainly target large employers with more than 1,000 employees, of which we believe there are approximately 18,000 in the United States. In our other market segment, we sell our solutions to insurance carriers, enabling us to expand our overall footprint in the benefits marketplace by aggregating many key constituents, including consumers, employers, and brokers. We believe our presence in both the employer and insurance carrier markets gives us a strong position at the center of the benefits ecosystem. As of June 30, 2013, we served over 20 million consumers on the Benefitfocus platform. In 2012, we served 286 large employer customers, an increase from 118 in 2009, and 34 carrier customers, an increase from 28 in 2009.

We sell the Benefitfocus platform on a subscription basis, typically through annual contracts with our employer customers and multi-year contracts with our insurance carrier customers, with subscription fees paid monthly. Our software-as-a-service, or SaaS, model provides us visibility into our future operating results through increased revenue predictability, which enhances our ability to manage our business. Historically, our annual software services revenue retention rate has been in

 

 

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excess of 95%. Our total revenue increased from $68.8 million in 2011 to $81.7 million in 2012, representing an 18.8% year-over-year increase. Our employer revenue increased from $15.9 million in 2011 to $23.8 million in 2012, representing a 49.0% year-over-year increase. Our carrier revenue increased from $52.8 million in 2011 to $58.0 million in 2012, representing a 9.7% year-over-year increase. We had net losses of $14.9 million in 2011 and $14.7 million in 2012, and $10.4 million and $15.2 million for the six months ended June 30, 2012 and 2013, respectively. Our company was founded in 2000, and we currently employ approximately 824 associates.

Industry Background

The administration and distribution of benefits to employees is costly and complex. It requires the exchange of information, application of rules, and transfer of funds among a wide variety of constituents, including consumers, employers, insurance carriers, brokers, benefits outsourcers, payroll processors, and financial institutions. According to IBISWorld calculations, in 2012, the market for human resources, or HR, benefits administration in the United States was over $59 billion. In addition, Gartner estimates that in 2012, the U.S. insurance industry spent over $55 billion on software and related services. 1 The current system for providing benefits is changing rapidly and suffers from significant inefficiency as a result of complexity, regulation, and the involvement of multiple parties, leaving room for substantial improvement along the entire benefits value chain.

Employer Market

As of 2010, according to the United States Census Bureau, there were approximately 5.7 million employers in the United States. Currently, we believe there are over 18,000 entities that employ more than 1,000 individuals. A significant and growing portion of employers’ costs is non-salary benefits, such as the health insurance that they provide to their employees. Employers recognize the importance of offering a greater variety of core and voluntary benefits as a means to attract, motivate, and retain employees. They must maintain relationships with multiple insurance carriers and many other benefits providers, placing a substantial administrative burden on their organizations.

Employers’ distribution, management, and administration of employee benefits has historically consisted of error-prone, paper-based processes, and a patchwork of customized software tools, which are costly to maintain, often lack necessary functionality, and fail to address the increasing complexity of the benefits marketplace. Employers are increasingly interested in SaaS solutions that can help capture and analyze benefits data, increase efficiency and contain costs, and ultimately lead to healthier, happier, and more productive employees.

Insurance Carrier Market

The employee benefits market consists of a myriad of insurance carriers and products. According to the U.S. Bureau of Labor Statistics, the single largest benefit provided to employees in the United States is healthcare insurance, often encompassing more than 90% of all insurance benefits spending by employers. According to SNL Financial data, the U.S. private healthcare insurance market consists of approximately 313 carriers covering approximately 176 million individual consumers. Carriers provide benefits primarily through over 5.7 million U.S. employers.

Carrier IT systems typically consist of an enterprise software platform that handles claims management, claims re-pricing, insurance premium billing, network management, and case management. Despite widespread carrier consolidation, numerous disparate systems remain in place,

 

1   Gartner, Forecast: Enterprise IT Spending by Vertical Industry Market, Worldwide, 1Q13 Update , United States Insurance Market Spending on Software, IT Services, and Internal Services.

 

 

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with many large carriers operating on multiple IT systems. The effective delivery and management of healthcare benefits depends on the timely, continuous exchange of data among carriers, their employer customers, and individual members. Legacy benefits management systems often lack important functionality such as web and mobile self-service capabilities and real-time data exchange. Critical carrier processes, including member enrollment, billing, communications, and retail marketing have often been under-optimized or neglected by legacy systems, and carriers have devoted significant internal resources to cover technology gaps.

Governmental oversight, punctuated with the passage of the Patient Protection and Affordable Care Act, or PPACA, has led to an increasingly intricate regulatory framework under which health benefits are delivered, accessed, and maintained. PPACA significantly expands insurance coverage through the individual mandate, with the goal of providing healthcare insurance to all U.S. citizens. To encourage enrollment, PPACA introduces a new distribution model in the form of healthcare exchanges—online marketplaces that allow insurance carriers to compete directly for new members. PPACA authorized the creation of publicly funded state exchanges in which individuals and small businesses can purchase health insurance directly from carriers. In addition to these federally mandated public exchanges, a number of private entities, including benefit outsourcers, carriers, and brokers are establishing their own private exchanges. We expect private exchanges will be less rigid, promoting both health and non-health benefits, with substantially fewer rules around the types of benefits offered. As insurance carriers continue to bolster their retail distribution capabilities, we believe they will require new technology solutions to attract additional members through private exchanges.

The Benefitfocus Solutions

We provide a multi-tenant cloud-based benefits platform to the employer and carrier markets. The Benefitfocus platform offers an integrated suite of software solutions that enables our customers to more efficiently shop, enroll, manage, and exchange benefits information.

We believe our solutions help employers in the following important ways:

 

  Ÿ  

Simplify Benefits Enrollment .    Our solutions reduce the complexity of benefits enrollment by integrating all plan information in one place and presenting it to employees in an organized and easy-to-understand manner. Employees shop and enroll using a highly intuitive and engaging consumer-oriented interface.

 

  Ÿ  

Transition to Defined Contribution Benefits Funding Model .    Our solutions help enable employers’ ongoing shift to defined contribution plans. Defined contribution plans differ from traditional defined benefit plans as they grant employees a stipend with which to purchase benefits of their choosing. Defined contribution plans also offer more discretion and options compared to defined benefit plans. Our products support traditional defined benefit plans, allowing employees to select from a list of benefits offered by their employer, calculating required member contributions, and recording and transmitting elections and other important information to payroll. Separately, with respect to defined contribution plans, our exchange solutions help facilitate an online shopping environment with many benefits options that allows employees to select personalized benefit offerings to suit their individual needs.

 

  Ÿ  

Reduce Cost and Increase ROI .    Our solutions automate the benefits management process and reduce the cost associated with clerical errors and covering ineligible employees and dependents. Our solutions also include advanced analytics that enable employers and employees to quickly gather, report, and forecast benefit costs.

 

 

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  Ÿ  

Attract, Retain, and Motivate Employees .    Our solutions help employers attract, retain, and motivate top talent by delivering benefits information through a highly intuitive and engaging user interface. We believe that when employees understand the value of their benefits, they are more likely to be satisfied with and engaged in their jobs.

 

  Ÿ  

Streamline HR Processes.     Our solutions eliminate the time-consuming and labor-intensive, often paper-based, processes associated with managing employee benefits plans, making HR professionals more efficient. Employers and HR professionals can efficiently enroll users or update information, and communicate or make changes to plans in real-time.

 

  Ÿ  

Integrate Seamlessly with other Related Systems.     Our solutions can be easily and securely integrated with a variety of related systems, including carrier membership and billing systems, payroll and HR systems, banks, and other third-party administrators. We provide a network of over 900 benefit provider data exchange connections. Our open architecture further extends our functionality by allowing third parties to develop and offer apps and services on our platform.

We believe our solutions help insurance carriers in the following important ways:

 

  Ÿ  

Attract and Maintain Membership.     Our solutions allow carriers to maximize sales capacity and efficiency by communicating directly with their employer customers and individual members. Carriers can track leads, generate quotes, create proposals with multiple products, and quickly follow-up with potential customers and members.

 

  Ÿ  

Reduce Administrative Costs.     The Benefitfocus platform allows carriers to automate and simplify various aspects of the benefits administration process, such as enrollment, plan changes, eligibility updates, and billing, from one centralized location.

 

  Ÿ  

Bolster Retail Distribution Capabilities Through Private Exchanges.     Our solutions help carriers respond to an evolving marketplace in which retail distribution capabilities are increasingly important to attracting and retaining new members. Our private exchange platform offers carriers a lower cost direct sales channel to employer groups and individuals. We offer the ability to sell both healthcare and non-healthcare benefit products in an online shopping environment that serves as an alternative to government-sponsored public exchanges.

 

  Ÿ  

Facilitate Real-Time Data Exchange.     Our solutions simplify interactions and data exchange and foster collaboration among carriers and their partners, brokers, employer customers, and individual members. This allows carriers to rapidly tailor and offer new benefits packages.

Our Growth Strategy

We intend to strengthen our position as a leading provider of cloud-based benefits software solutions. Key elements of our growth strategy include the following:

 

  Ÿ  

Expand our Customer Base.     We believe that our current customer base represents a small fraction of our targeted employers and carriers that could benefit from our solutions. In order to reach new customers in our existing employer and carrier markets, we are aggressively investing in our sales and marketing resources.

 

  Ÿ  

Deepen our Relationships with our Existing Customer Base.     We are deepening our employer relationships by continuing to provide a unified platform to manage increasingly complex

 

 

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benefits processes and simplify the distribution and administration of employee benefits. We are expanding our carrier relationships through both the upsell of additional software products and increased adoption across our carriers’ member populations.

 

  Ÿ  

Extend our Suite of Applications and Continue our Technology Leadership.     We are extending the number, range, and functionality of our benefits applications. For example, we recently launched the new Benefitfocus Plan Shopping app, which allows employees to use actual claims data when comparing available benefits plans. We have also extended the functionality of our products with various mobile applications. We intend to continue our collaboration with customers and partners, so we can respond quickly to evolving market needs with innovative applications and support our leadership position.

 

  Ÿ  

Further Develop our Partner Ecosystem.     We have established strong relationships with organizations such as SuccessFactors, Allstate Insurance Company, the Mayo Clinic, and others in a variety of industries to deliver best-in-class applications to our customers. We plan to continue to invest in our integration infrastructure to allow third parties and customers to build custom applications on the Benefitfocus platform and create deep integrations between their systems and ours.

 

  Ÿ  

Leverage our Corporate Culture.     We believe our culture benefits our associates and customers and supports our growth. We plan to continue to invest in our culture to help attract and retain top design and engineering professionals that are passionate about Benefitfocus and motivated to create superior software technology.

 

  Ÿ  

Target New Markets.     We believe substantial demand for our solutions exists in markets and geographies beyond our current focus. We intend to leverage opportunities we believe will arise from the complexities of changing government regulation and increased enrollment impacting both Medicare and Medicaid. We also plan to grow our sales capability internationally by expanding our direct sales force and collaborating with strategic partners in new, international locations.

Selected Risks Affecting Our Business

Our business is subject to a number of risks you should be aware of before making an investment decision. These risks are discussed more fully in “Risk Factors” beginning on page 12 and include:

 

  Ÿ  

We have had a history of losses, and we might not be able to achieve or sustain profitability.

 

  Ÿ  

Our quarterly operating results have fluctuated in the past and might continue to fluctuate, causing the value of our common stock to decline substantially.

 

  Ÿ  

We operate in a highly competitive industry, and if we are not able to compete effectively, our business and operating results will be harmed.

 

  Ÿ  

The market for our products and services is immature and volatile, and if it does not develop or if it develops more slowly than we expect, the growth of our business will be harmed.

 

  Ÿ  

If the number of individuals covered by our employer and carrier customers decreases or the number of products or services to which our employer and carrier customers subscribe decreases, our revenue will decrease.

 

  Ÿ  

If our security measures are breached or fail and unauthorized access is obtained to customers’ data, our service might be perceived as not being secure, customers might curtail or stop using our service, and we might incur significant liabilities.

 

 

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  Ÿ  

We rely on third-party service providers, computer hardware and software, and our own systems for providing services to our customers, and any failure or interruption in these services, products or systems could expose us to litigation and negatively impact our customer relationships, adversely affecting our brand and our business.

 

  Ÿ  

Government regulation of the areas in which we operate creates risks and challenges with respect to our compliance efforts and our business strategies, imposes increased costs on us, delays or prevents our introduction of new service types, and could impair the function or value of our existing service types.

Corporate Restructuring

We are a Delaware corporation and a wholly owned subsidiary of Benefitfocus.com, Inc., the South Carolina corporation that conducts our business. Prior to the closing of this offering, we intend to restructure our organization by merging Benefitfocus.com, Inc. with a newly formed South Carolina corporation, which is a wholly owned subsidiary of ours. As a result of the restructuring, the common and preferred shareholders of Benefitfocus.com, Inc. will become common and preferred stockholders, respectively, of Benefitfocus, Inc. Also as a result of the restructuring, warrants that are exercisable for common shares of Benefitfocus.com, Inc. will become exercisable for common shares of Benefitfocus, Inc. Similarly, holders of options to purchase common shares of Benefitfocus.com, Inc. will become holders of options to purchase shares of common stock of Benefitfocus, Inc. Except as otherwise provided herein, this prospectus gives effect to the corporate restructuring.

In connection with the corporate restructuring, we expect to effect a stock split of shares of our capital stock issued and outstanding and shares of our capital stock issued and held in treasury at a ratio of up to five shares for each current share, with the exact ratio to be determined by our board of directors. Except as otherwise provided herein, this prospectus does not give effect to the stock split.

Corporate Information

Our principal executive offices are located at 100 Benefitfocus Way, Charleston, South Carolina 29492. The telephone number of our principal executive offices is (843) 849-7476. Our website is www.benefitfocus.com . Information contained on our website is not incorporated by reference into this prospectus, and you should not consider information contained on our website to be part of this prospectus or in deciding whether to purchase shares of our common stock.

Benefitfocus, HR InTouch, HR InTouch Marketplace, Benefitfocus eEnrollment, Benefitfocus eBilling, Benefitfocus eExchange, Benefitfocus eSales, and other trademarks or service marks of Benefitfocus appearing in this prospectus are the property of Benefitfocus. This prospectus may refer to brand names, trademarks, service marks, or trade names of other companies and organizations, and these brand names, trademarks, service marks, and trade names are the property of their respective holders.

 

 

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The Offering

 

Common stock offered by Benefitfocus

 

             shares

Common stock offered by the selling stockholders

 

             shares

Common stock to be outstanding after this offering

 

             shares

Option to purchase additional shares offered to underwriters

 

To the extent that the underwriters sell more than              shares of common stock, the underwriters have the option to purchase up to an additional              shares from us and up to an additional              shares from the selling stockholders. The underwriters can exercise this option at any time within 30 days from the date of this prospectus.

Use of proceeds

  We intend to use the net proceeds we receive from this offering for working capital purposes and other general corporate purposes, including executing our growth strategy, developing new products and services, and funding additional capital expenditures, potential acquisitions, and investments. We will not receive any proceeds from the shares sold by the selling stockholders. See “Use of Proceeds” for more information.

Proposed NASDAQ Stock Market symbol

 

“BNFT”

The number of shares of our common stock to be outstanding after this offering is based on 21,312,049 shares outstanding as of June 30, 2013, after giving effect to the assumptions in the following paragraph, and excludes:

 

  Ÿ  

3,243,356 shares of common stock issuable upon exercise of stock options outstanding at a weighted-average exercise price of $6.50 per share, of which 2,460,377 shares with a weighted-average exercise price of $5.52 per share were vested and exercisable;

 

  Ÿ  

500,000 shares of common stock issuable upon exercise of a warrant at an exercise price of $5.48 per share; and

 

  Ÿ  

175,055 shares of common stock available for future issuance under our stock plans.

Except as otherwise indicated, all information in this prospectus:

 

  Ÿ  

assumes no exercise by the underwriters of their option to purchase up to an additional              shares from us and up to an additional              shares from the selling stockholders;

 

  Ÿ  

assumes that the shares to be sold in this offering are sold at the initial public offering price of $         per share, the midpoint of the estimated price range shown on the cover of this prospectus;

 

  Ÿ  

gives effect to the automatic conversion of all outstanding shares of convertible preferred stock into 16,496,860 shares of common stock upon the closing of this offering; and

 

  Ÿ  

gives effect to our corporate restructuring prior to the closing of this offering as described in the section entitled “Certain Relationships and Related-Party Transactions—Corporate Restructuring,” but not to the stock split we expect to effect in connection therewith.

 

 

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Summary Financial Data

The following summary financial data should be read in conjunction with the sections entitled “Selected Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements, related notes, and other financial information included elsewhere in this prospectus. Except for 2010 balance sheet data, we derived the summary financial data as of and for the years ended December 31, 2010, 2011, and 2012 from our audited financial statements included elsewhere in this prospectus. We derived the 2010 balance sheet data from audited financial statements not included in this prospectus. We have derived the following summary consolidated statement of operations data for the six months ended June 30, 2012 and 2013 and balance sheet data as of June 30, 2013 from our unaudited consolidated interim financial statements appearing elsewhere in this prospectus. Our historical results for any prior period are not necessarily indicative of results to be expected in any future period, and our operating results for the six months ended June 30, 2013 are not necessarily indicative of the results to be expected for the entire year ending December 31, 2013.

Consolidated Statements of Operations Data

 

    Years Ended December 31,     Six Months Ended
June 30,
 
    2010     2011     2012     2012     2013  
   

(in thousands, except share and per share data)

 

Revenue(1)

  $ 67,122      $ 68,783      $ 81,739      $ 38,698      $ 48,179   

Cost of revenue(2)

    39,817        43,034        45,178        22,231        27,170   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    27,305        25,749        36,561        16,467        21,009   

Operating expenses:

         

Sales and marketing(2)

    14,462        22,914        28,268        15,064        19,905   

Research and development(2)

    8,948        9,397        15,035        7,710        10,505   

General and administrative(2)

    6,144        5,921        7,577        3,753        5,608   

Impairment of goodwill

           1,670                        

Change in fair value of contingent consideration

           503        121        170        (43
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    29,554        40,405        51,001        26,697        35,975   

Loss from operations

    (2,249     (14,656     (14,440     (10,230     (14,966
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense, net

    (96     (241     (214     (99     (173
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (2,345     (14,897     (14,654     (10,329     (15,139

Income tax expense

    10        35        84        39        40   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

  $ (2,355   $ (14,932   $ (14,738   $ (10,368   $ (15,179
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share—basic and diluted

  $ (0.37   $ (3.06   $ (3.06   $ (2.15   $ (3.16
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net loss per share- basic and diluted(3)

      $ (0.69     $ (0.71
     

 

 

     

 

 

 

Weighted-average common shares outstanding—basic and diluted

    6,405,944        4,875,157        4,812,632        4,818,117        4,803,812   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding—pro forma

        21,309,492          21,300,672   
     

 

 

     

 

 

 

Other Financial Data:

         

Adjusted gross profit(4)

  $ 33,498      $ 32,163      $ 44,164      $ 20,794      $ 24,420   

Adjusted EBITDA(5)

  $ 5,245      $ (5,209   $ (5,445   $ (5,162   $ (10,692

 

 

 

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(1) In the first quarter of 2011, we increased the estimated expected life of our customer relationships for both employer and carrier customers. This change extends the term over which we will recognize our deferred revenue. In the absence of this change, each of revenue, gross profit, and net loss would have improved by $5.8 million in 2011 and $2.8 million in 2012.

 

(2) Cost of revenue and operating expenses include stock-based compensation expense as follows:

 

     Year Ended December 31,      Six Months Ended
June 30,
 
     2010      2011      2012      2012      2013  
    

(in thousands)

 

Cost of revenue

   $ 352       $ 252       $ 195       $ 84       $ 131   

Sales and marketing

     77         102         68         30         64   

Research and development

     87         121         130         57         133   

General and administrative

     519         246         319         140         209   

 

(3) Pro forma basic and diluted net loss per share have been calculated assuming the conversion of all outstanding shares of redeemable convertible preferred stock into an aggregate of 16,496,860 shares of common stock as of the beginning of the applicable period.

 

(4) We define adjusted gross profit as gross profit before depreciation and amortization expense, as well as stock-based compensation expense. Please see “Adjusted Gross Profit and Adjusted EBITDA” below for more information and for a reconciliation of adjusted gross profit to gross profit, the most directly comparable financial measure calculated and presented in accordance with GAAP.

 

(5) We define adjusted EBITDA as net loss before net interest and other expense, taxes, and depreciation and amortization expense, adjusted to eliminate stock-based compensation expense and expense related to the impairment of goodwill. See “Adjusted Gross Profit and Adjusted EBITDA” below for more information and for a reconciliation of adjusted EBITDA to net loss, the most directly comparable financial measure calculated and presented in accordance with GAAP.

Our Segments

 

     Years Ended December 31,     Six Months Ended
June 30,
 
     2010     2011     2012     2012     2013  
    

(in thousands)

 

Revenue:

          

Employer

   $ 9,356      $ 15,947      $ 23,760      $ 10,461      $ 17,593   

Carrier

     57,766        52,836        57,979        28,237        30,586   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

   $ 67,122      $ 68,783      $ 81,739      $ 38,698      $ 48,179   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit:

          

Employer

   $ 2,926      $ 5,811      $ 9,499      $ 3,905      $ 6,947   

Carrier

     24,379        19,938        27,062        12,562        14,062   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total gross profit

   $ 27,305      $ 25,749      $ 36,561      $ 16,467      $ 21,009   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations:

          

Employer

   $ (7,036   $ (20,226   $ (19,778   $ (11,792   $ (12,443

Carrier

     4,787        5,570        5,338        1,562        (2,523
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loss from operations

   $ (2,249   $ (14,656   $ (14,440   $ (10,230   $ (14,966
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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Consolidated Balance Sheet Data

 

     As of June 30, 2013  
     Actual     Pro
Forma (1)
    Pro Forma As
Adjusted (2)
 
    

(in thousands)

 

Cash and cash equivalents

   $ 13,673      $ 13,673      $                

Accounts receivable, net

     18,793        18,793     

Total assets

     54,837        54,837     

Deferred revenue, total

     66,175        66,175     

Total liabilities

     98,705        98,705     

Total redeemable convertible preferred stock

     135,478            

Common stock

     7,190        21     

Additional paid-in capital

            142,647     

Total stockholders’ deficit

     (179,346     (43,868  

 

 

(1) The pro forma balance sheet data gives effect to the transactions described under “Certain Relationships and Related-Party Transactions—Corporate Restructuring” that will occur prior to the closing of this offering, and the conversion of all outstanding shares of redeemable convertible preferred stock into an aggregate of 16,496,860 shares of common stock, but not the stock split.

 

(2) The pro forma as adjusted balance sheet data (i) gives effect to the pro forma adjustments set forth in footnote 1 above, and (ii) also gives effect to our issuance and sale of              shares of common stock in this offering at an assumed initial public offering price of $             per share, the midpoint of the price range listed on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

The pro forma as adjusted information presented in the consolidated balance sheet data is illustrative only and will change based on the actual initial public offering price and other terms of this offering determined at pricing. Each $1.00 increase or decrease in the assumed initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus, would increase or decrease, as applicable, each of cash and cash equivalents, total assets and total stockholders’ equity on a pro forma as adjusted basis by approximately $            , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses.

Adjusted Gross Profit and Adjusted EBITDA

Within this prospectus we use adjusted gross profit and adjusted EBITDA to provide investors with additional information regarding our financial results. Adjusted gross profit and adjusted EBITDA are non-GAAP financial measures. We have provided below reconciliations of these measures to the most directly comparable GAAP financial measures, which for adjusted gross profit is gross profit, and for adjusted EBITDA is net loss.

We have included adjusted gross profit and adjusted EBITDA in this prospectus because they are key measures 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 gross profit and adjusted EBITDA can provide a useful measure for period-to-

 

 

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period comparisons of our core business. Accordingly, we believe that adjusted gross profit and adjusted EBITDA provide useful information to investors and others in understanding and evaluating our operating results.

Our use of adjusted gross profit and adjusted EBITDA as analytical tools has limitations, and you should not consider them in isolation or as substitutes for analysis of our financial results as reported under GAAP. Some of these limitations are:

 

  Ÿ  

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized might have to be replaced in the future, and adjusted gross profit and adjusted EBITDA do not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;

 

  Ÿ  

adjusted gross profit and adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs;

 

  Ÿ  

adjusted gross profit and adjusted EBITDA do not reflect the potentially dilutive impact of stock-based compensation;

 

  Ÿ  

adjusted gross profit and adjusted EBITDA do not reflect interest or tax payments that could reduce the cash available to us; and

 

  Ÿ  

other companies, including companies in our industry, might calculate adjusted gross profit and adjusted EBITDA or similarly titled measures differently, which reduces their usefulness as comparative measures.

Because of these and other limitations, you should consider adjusted gross profit and 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 a reconciliation of adjusted gross profit to gross profit and adjusted EBITDA to net loss for each of the periods indicated:

 

    Years Ended December 31,     Six Months Ended
June 30,
 
    2010     2011     2012     2012     2013  
    (in thousands)  

Reconciliation from Gross Profit to Adjusted Gross Profit:

         

Gross profit

  $ 27,305      $ 25,749      $ 36,561      $ 16,467      $ 21,009   

Depreciation and amortization

    5,841        6,162        7,408        4,243        3,280   

Stock-based compensation expense

    352        252        195        84        131   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted gross profit

  $ 33,498      $ 32,163      $ 44,164      $ 20,794      $ 24,420   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reconciliation from Net Loss to Adjusted EBITDA:

         

Net loss

  $ (2,355   $ (14,932   $ (14,738   $ (10,368   $ (15,179

Depreciation and amortization

    6,343        7,040        8,294        4,754        3,752   

Interest expense

    212        203        203        102        158   

Income tax expense

    10        35        84        39        40   

Stock-based compensation expense

    1,035        721        712        311        537   

Impairment of goodwill and intangible assets

           1,724                        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net adjustments

  $ 7,600      $ 9,723      $ 9,293      $ 5,206      $ 4,487   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 5,245      $ (5,209   $ (5,445   $ (5,162   $ (10,692
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with all of the other information in this prospectus, including the consolidated financial statements and the related notes appearing at the end of this prospectus, before deciding to invest in shares of our common stock. If any of the following risks were to materialize, our business, financial condition, results of operations, and future growth prospects could be materially and adversely affected. In that event, the market price of our common stock could decline and you could lose part or all of your investment in our common stock.

Risks Related to Our Business

We have had a history of losses, and we may be unable to achieve or sustain profitability.

We experienced a net loss of $2.4 million in 2010, $14.9 million in 2011 and $14.7 million in 2012, and net losses of $10.4 million and $15.2 million in the six months ended June 30, 2012 and 2013, respectively. We cannot predict if we will achieve sustained profitability in the near future or at all. We expect to make significant future expenditures to develop and expand our business. In addition, as a public company, we will incur significant legal, accounting, and other expenses that we did not incur as a private company. These increased expenditures will make it harder for us to achieve and maintain future profitability. Our recent growth in revenue and number of customers may not be sustainable, and we might not achieve sufficient revenue to achieve or maintain profitability. We may incur significant losses in the future for a number of reasons, including the other risks described in this prospectus, and we may encounter unforeseen expenses, difficulties, complications and delays and other unknown events. Accordingly, we may not be able to achieve or maintain profitability and we may incur significant losses for the foreseeable future.

Our quarterly operating results have fluctuated in the past and might continue to fluctuate, causing the value of our common stock to decline substantially.

Our quarterly operating results might fluctuate due to a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis might not be meaningful. You should not rely on our past results as indicative of our future performance. Moreover, our stock price might be based on expectations of future performance that are unrealistic or that we might not meet and, if our revenue or operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially.

Our operating results have varied in the past. In addition to other risk factors listed in this section, some of the important factors that may cause fluctuations in our quarterly operating results include:

 

  Ÿ  

the extent to which our products and services achieve or maintain market acceptance;

 

  Ÿ  

our ability to introduce new products and services and enhancements to our existing products and services on a timely basis;

 

  Ÿ  

new competitors and the introduction of enhanced products and services from competitors;

 

  Ÿ  

the financial condition of our current and potential customers;

 

  Ÿ  

changes in customer budgets and procurement policies;

 

  Ÿ  

the amount and timing of our investment in research and development activities;

 

  Ÿ  

technical difficulties with our products or interruptions in our services;

 

  Ÿ  

our ability to hire and retain qualified personnel, including the rate of expansion of our sales force;

 

  Ÿ  

changes in the regulatory environment related to benefits and healthcare;

 

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  Ÿ  

regulatory compliance costs;

 

  Ÿ  

the timing, size, and integration success of potential future acquisitions; and

 

  Ÿ  

unforeseen legal expenses, including litigation and settlement costs.

In addition, a significant portion of our operating expense is relatively fixed in nature, and planned expenditures are based in part on expectations regarding future revenue. Accordingly, unexpected revenue shortfalls might decrease our gross margins and could cause significant changes in our operating results from quarter to quarter. If this occurs, the trading price of our common stock could fall substantially, either suddenly or over time.

As a result of our variable sales and implementation cycles, we might not be able to recognize revenue to offset expenditures, which could result in fluctuations in our quarterly results of operations or otherwise harm our future operating results.

The sales cycle for our products and services can be variable, averaging four months in our employer market segment and 15 months in our carrier market segment, each from initial contact to contract execution. During the sales cycle, we expend time and resources, and we do not recognize any revenue to offset such expenditures.

After a customer contract is signed, we provide an implementation process for the customer during which we establish and test appropriate integrations, connections and registrations, load data into our system, and train customer personnel. Our implementation cycle is also variable, typically ranging from four to five months for employer implementations and from eight to 10 months for complex carrier implementations, each from contract execution to completion of implementation. Some of our new customer projects are complex and require a lengthy set-up period and significant implementation work. During the implementation cycle, we expend substantial time, effort, and financial resources implementing our products and services, but accounting principles do not allow us to recognize the resulting revenue until implementation is complete and the services are available for use, at which time we begin recognition of implementation revenue over the longer of the life of the contract or the expected life of the customer relationship. Each customer’s situation is different, and unanticipated difficulties and delays might arise as a result of failure by us or by the customer to complete our respective responsibilities. If implementation periods are extended, revenue recognition could be delayed and our financial condition might be adversely affected. In addition, cancellation of any implementation after it has begun might result in lost time, effort, and expenses invested in the cancelled implementation process and lost opportunity for implementing paying clients in that same period of time.

These factors might contribute to substantial fluctuations in our quarterly operating results. As a result, in future quarters, our operating results could fall below the expectations of securities analysts or investors, in which event our stock price would likely decline.

Because we recognize revenue and expense relating to monthly subscriptions and professional services over varying periods, downturns or upturns in sales are not immediately reflected in full in our operating results.

As a software-as-a-service, or SaaS, company, we recognize our subscription revenue monthly for the term of our contracts and recognize the majority of our professional services revenue ratably over the longer of the contract term or the estimated expected life of the customer relationship. As a result, a portion of the revenue we report each quarter is the recognition of deferred revenue from contracts we entered into during previous quarters. Consequently, a shortfall in demand for our software solutions and professional services or a decline in new or renewed contracts in any one quarter might not significantly reduce our revenue for that quarter, but could negatively affect our

 

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revenue in future quarters. Accordingly, the effect of significant downturns in new or renewed sales of our products and services is not reflected in full in our results of operations until future periods. Our revenue recognition model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, because revenue from new customers must be recognized over the applicable term of the contracts or the estimated expected life of the customer relationship period. In addition, as a result of negotiations with our customers, we may charge rates for our professional services that would cause professional services to generate negative gross profit, based on our determination when we are pricing our products about how much of the subscription price to allocate between professional services and software services. This may have the effect of causing reported revenue for software services to be higher than it would be if we charged the full cost of professional services on each contract.

We were in default under our credit facility as of June 30, 2013, and if we default again, the lender could declare all outstanding amounts due and terminate the facility as to future advances, which might have an adverse impact on our liquidity.

As of June 30, 2013, we were not in compliance with the net operating income covenant under our master credit facility. Although the lender waived this breach, as well as any future breaches of the net operating income covenant through August 1, 2014, we cannot assure you that we will satisfy the net operating income covenant by that time or any of the other covenants under the master credit facility in the future or that the lender will waive any future breaches. If we default on our obligations under the master credit facility again, the lender could declare all outstanding amounts due and terminate the facility. We would be required to pay off the credit facility from cash on hand, proceeds of this offering, or a new credit facility, which might adversely impact our liquidity.

We operate in a highly competitive industry, and if we are not able to compete effectively, our business and operating results will be harmed.

The benefits management software market is highly competitive and is likely to attract increased competition, which could make it hard for us to succeed. Small, specialized providers continue to become more sophisticated and effective. In addition, large, well-financed, and technologically sophisticated software companies might focus more on our market. The size and financial strength of these entities is increasing as a result of continued consolidation in both the IT and healthcare industries. We expect large integrated software companies to become more active in our market, both through acquisitions and internal investment. As costs fall and technology improves, increased market saturation might change the competitive landscape in favor of our competitors.

Some of our current large competitors have greater name recognition, longer operating histories, and significantly greater resources than we do. As a result, our competitors might be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards, or customer requirements. In addition, current and potential competitors have established, and might in the future establish, cooperative relationships with vendors of complementary products, technologies, or services to increase the availability of their products in the marketplace. Accordingly, new competitors or alliances might emerge that have greater market share, a larger customer base, more widely adopted proprietary technologies, greater marketing expertise, greater financial resources, and larger sales forces than we have, which could put us at a competitive disadvantage. Further, in light of these advantages, even if our products and services are more effective than those of our competitors, current or potential customers might accept competitive offerings in lieu of purchasing our offerings. Increased competition is likely to result in pricing pressures, which could negatively impact our sales, profitability, or market share. In addition to new niche vendors, who offer stand-alone products and services, we face competition from existing enterprise vendors, including those currently focused on software solutions that have information systems in place with potential customers in our target market. These existing enterprise vendors might promise products or services that offer ease of integration with

 

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existing systems and which leverage existing vendor relationships. In addition, large insurance carriers often have internal technology staffs and proprietary software for benefits management, making them less likely to buy our solutions.

The market for our products and services is immature and volatile, and if it does not develop or if it develops more slowly than we expect, the growth of our business will be harmed.

The cloud-based benefits management software market is relatively new and unproven, and it is uncertain whether it will achieve and sustain high levels of demand and market acceptance. Our success will depend to a substantial extent on the willingness of employers, carriers, and consumers to increase their use of benefits management software. Many employers and carriers have invested substantial personnel and financial resources to integrate internally developed solutions or traditional enterprise software into their businesses for benefits management, and therefore might be reluctant or unwilling to migrate to our cloud-based solutions. If employers, carriers and consumers do not perceive the benefits of our solutions, then our market might not develop at all, or it might develop more slowly than we expect, either of which could significantly adversely affect our operating results. In addition, we have limited insight into trends that might develop and affect our business. We might make errors in predicting and reacting to relevant business trends, which could harm our business. If any of these risks occur, it could materially adversely affect our business, financial condition or results of operations.

The SaaS pricing model is evolving and our failure to manage its evolution and demand could lead to lower than expected revenue and profit.

We derive most of our revenue growth from subscription offerings and, specifically, SaaS offerings. This business model depends heavily on achieving economies of scale because the initial upfront investment is costly and the associated revenue is recognized on a ratable basis. If we fail to achieve appropriate economies of scale or if we fail to manage or anticipate the evolution and demand of the SaaS pricing model, then our business and operating results could be adversely affected.

If we do not continue to innovate and provide products and services that are useful to consumers, employers, insurance carriers, and brokers and provide high quality support services, we might not remain competitive, and our revenue and operating results could suffer.

Our success depends in part on providing products and services that consumers, employers, insurance carriers, and brokers will use to manage benefits. We must continue to invest significant resources in research and development in order to enhance our existing products and services and introduce new high quality products and services that customers will want. If we are unable to predict user preferences or industry changes, or if we are unable to modify our products and services on a timely basis, we might lose customers. Our operating results would also suffer if our innovations are not responsive to the needs of our customers, are not appropriately timed with market opportunity, or are not effectively brought to market. As technology continues to develop, our competitors might be able to offer results that are, or that are perceived to be, substantially similar to or better than those generated by us. This would force us to compete on additional product and service attributes and to expend significant resources in order to remain competitive.

In addition, we may experience difficulties with software development, industry standards, design, or marketing that could delay or prevent our development, introduction, or implementation of new solutions and enhancements. The introduction of new solutions by competitors, the emergence of new industry standards, or the development of entirely new technologies to replace existing offerings could render our existing or future solutions obsolete.

Our success also depends on providing high quality support services to resolve any issues related to our products and services. High quality education and customer support is important for the

 

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successful marketing and sale of our products and services and for the renewal of existing customers. If we do not help our customers quickly resolve issues and provide effective ongoing support, our ability to sell additional products and services to existing customers would suffer and our reputation with existing or potential customers would be harmed.

If we are unable to retain our existing customers, our revenue and results of operations would be adversely affected.

We sell our products and services pursuant to agreements that are generally one year for employers and three to five years for carriers. While our employer contracts generally automatically renew on an annual basis, our carrier customers have no obligation to renew their contracts after their contract period expires, and these contracts may not be renewed on the same or on more profitable terms if at all. Additionally, some of our carrier customers are able to terminate their respective contracts without cause or for convenience, although generally our carrier contracts are only cancellable by the carrier in an instance of our uncured breach. As a result, our ability to grow depends in part on the continuance and renewal of our carrier contracts. We may not be able to accurately predict future trends in customer renewals, and our customers’ renewal rates may decline or fluctuate because of several factors, including their level of satisfaction or dissatisfaction with our services, the cost of our services, the cost of services offered by our competitors, or reductions in our customers’ spending levels. If our carrier customers terminate or do not renew their contracts for our services, renew on less favorable terms, or do not purchase additional functionality or products, our revenue may grow more slowly than expected or decline, and our profitability and gross margins may be harmed.

A significant amount of our revenue is derived from our largest customers, and any reduction in revenue from any of these customers would reduce our revenue and net income.

Our ten largest customers by revenue in the past three years accounted for approximately 70.0%, 64.1%, and 58.6% of our consolidated revenue in each of 2010, 2011, and 2012, respectively. Our largest customer by revenue in the past three years accounted for approximately 11.6%, 11.7%, and 10.5% of our revenue in each of 2010, 2011, and 2012, respectively. If any of our key customers decides not to renew its contracts with us, or to renew on less favorable terms, our business, revenues, reputation, and our ability to obtain new customers could be materially and adversely affected.

If the number of individuals covered by our employer and carrier customers decreases or the number of products or services to which our employer and carrier customers subscribe decreases, our revenue will decrease.

Under most of our customer contracts, we base our fees on the number of individuals to whom our customers provide benefits and the number of products or services subscribed to by our customers. Many factors may lead to a decrease in the number of individuals covered by our customers and the number of products or services subscribed to by our customers, including:

 

  Ÿ  

failure of our customers to adopt or maintain effective business practices;

 

  Ÿ  

changes in the nature or operations of our customers;

 

  Ÿ  

government regulations; and

 

  Ÿ  

increased competition or other changes in the benefits marketplace.

If the number of individuals covered by our customers or the number of products or services subscribed to by our customers decreases for any reason, our revenue will likely decrease.

 

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Economic uncertainties or downturns in the general economy or the industries in which our customers operate could disproportionately affect the demand for our solutions and negatively impact our results of operations.

General worldwide economic conditions have experienced a significant downturn, and market volatility and uncertainty remain widespread, making it extremely difficult for our customers and us to accurately forecast and plan future business activities. In addition, these conditions could cause our customers or prospective customers to decrease headcount, benefits, or HR budgets, which could decrease corporate spending on our products and services, resulting in delayed and lengthened sales cycles, a decrease in new customer acquisition, and/or loss of customers. Furthermore, during challenging economic times, our customers may have difficulty gaining timely access to sufficient credit or obtaining credit on reasonable terms, which could impair their ability to make timely payments to us and adversely affect our revenue. If that were to occur, our financial results could be harmed. Further, challenging economic conditions might impair the ability of our customers to pay for the products and services they already have purchased from us and, as a result, our write-offs of accounts receivable could increase. We cannot predict the timing, strength, or duration of any economic slowdown or recovery. If the condition of the general economy or markets in which we operate worsens, our business could be harmed.

Failure to manage our rapid growth effectively could increase our expenses, decrease our revenue, and prevent us from implementing our business strategy.

We have been experiencing a period of rapid growth, which puts strain on our business. To manage this and our anticipated future growth effectively, we must continue to maintain and enhance our IT infrastructure, financial and accounting systems, and controls. We also must attract, train, and retain a significant number of qualified sales and marketing personnel, customer support personnel, professional services personnel, software engineers, technical personnel, and management personnel. Failure to effectively manage our rapid growth could lead us to over-invest or under-invest in development and operations, result in weaknesses in our infrastructure, systems, or controls, give rise to operational mistakes, losses, loss of productivity or business opportunities, and result in loss of employees and reduced productivity of remaining employees. Our growth could require significant capital expenditures and might divert financial resources from other projects such as the development of new products and services. If our management is unable to effectively manage our growth, our expenses might increase more than expected, our revenue could decline or might grow more slowly than expected, and we might be unable to implement our business strategy. The quality of our products and services might suffer, which could negatively affect our reputation and harm our ability to retain and attract customers.

We depend on our senior management team, and the loss of one or more key associates or an inability to attract and retain highly skilled associates could adversely affect our business.

Our success depends largely upon the continued services of our key executive officers. We also rely on our leadership team in the areas of research and development, marketing, services, and general and administrative functions, and on mission-critical individual contributors in research and development. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives, which could disrupt our business. The loss of one or more of our executive officers or key associates could have a serious adverse effect on our business.

To continue to execute our growth strategy, we also must attract and retain highly skilled personnel. Competition is intense for engineers with high levels of experience in designing and developing software and Internet-related services. We might not be successful in maintaining our unique culture and continuing to attract and retain qualified personnel. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and

 

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retaining highly skilled personnel with appropriate qualifications. The pool of qualified personnel with SaaS experience and/or experience working with the benefits market is limited overall and specifically in Charleston, South Carolina, where our principal office is located. In addition, many of the companies with which we compete for experienced personnel have greater resources than we have and are located in geographic areas, like Silicon Valley, that may attract more qualified technology workers.

In addition, in making employment decisions, particularly in the Internet and high-technology industries, job candidates often consider the value of the stock options they are to receive in connection with their employment. Volatility in the price of our stock might, therefore, adversely affect our ability to attract or retain highly skilled personnel. Furthermore, the requirement to expense stock options might discourage us from granting the size or type of stock option awards that job candidates require to join our company. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be severely harmed.

If we fail to maintain awareness of our brand cost-effectively, our business might suffer.

We believe that maintaining awareness of our brand in a cost-effective manner is critical to continuing the widespread acceptance of our existing solutions and is an important element in attracting new customers. Furthermore, we believe that the importance of brand recognition will increase as competition in our market increases. Successful promotion of our brand will depend largely on the effectiveness of our marketing efforts and on our ability to provide reliable and useful services at competitive prices. Our efforts to build and maintain our brand nationally have involved significant expenses. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses we incur in maintaining our brand. If we fail to successfully maintain our brand, or incur substantial expenses in an unsuccessful attempt to maintain our brand, we may fail to attract enough new customers or retain our existing customers to the extent necessary to realize a sufficient return on our brand-building efforts, and our business could suffer.

Our growth depends in part on the success of our strategic relationships with third parties.

In order to grow our business, we anticipate that we will continue to depend on our relationships with third parties, including our partner organizations, and technology and content providers. Identifying partners, and negotiating and documenting relationships with them, requires significant time and resources. Our competitors might be effective in providing incentives to third parties to favor their products or services or to prevent or reduce subscriptions to our products and services. In addition, acquisitions of our partners by our competitors could result in a decrease in the number of our current and potential customers, as our partners may no longer facilitate the adoption of our applications by potential customers. If we are unsuccessful in establishing or maintaining our relationships with third parties, our ability to compete in the marketplace or to grow our revenue could be impaired and our operating results may suffer. Even if we are successful, we cannot assure you that these relationships will result in increased customer use of our applications or increased revenue.

If we are required to collect sales and use taxes in additional jurisdictions, we might be subject to liability for past sales and our future sales may decrease.

We might lose sales or incur significant expenses if states successfully impose broader guidelines on state sales and use taxes. A successful assertion by one or more states requiring us to collect sales or other taxes on the licensing of our software or sale of our services could result in substantial tax liabilities for past transactions and otherwise harm our business. Each state has different rules and regulations governing sales and use taxes, and these rules and regulations are subject to varying interpretations that change over time. We review these rules and regulations periodically and, when we believe we are subject to sales and use taxes in a particular state, voluntarily engage state tax authorities in order to determine how to comply with their rules and

 

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regulations. We cannot assure you that we will not be subject to sales and use taxes or related penalties for past sales in states where we currently believe no such taxes are required.

Vendors of services, like us, are typically held responsible by taxing authorities for the collection and payment of any applicable sales and similar taxes. If one or more taxing authorities determines that taxes should have, but have not, been paid with respect to our services, we might be liable for past taxes in addition to taxes going forward. Liability for past taxes might also include substantial interest and penalty charges. Our customer contracts typically provide that our customers must pay all applicable sales and similar taxes. Nevertheless, our customers might be reluctant to pay back taxes and might refuse responsibility for interest or penalties associated with those taxes. If we are required to collect and pay back taxes and the associated interest and penalties, and if our clients fail or refuse to reimburse us for all or a portion of these amounts, we will incur unplanned expenses that may be substantial. Moreover, imposition of such taxes on us going forward will effectively increase the cost of our software and services to our customers and might adversely affect our ability to retain existing customers or to gain new customers in the areas in which such taxes are imposed.

We might not be able to utilize a significant portion of our net operating loss or other tax credit carryforwards, which could adversely affect our profitability.

As of December 31, 2012, we had federal and state net operating loss carryforwards due to prior period losses, which if not utilized will begin to expire in 2016 and 2019 for federal and state purposes, respectively. We also have South Carolina jobs tax credit and headquarters tax credit carryforwards, which if not utilized will begin to expire in 2019. These tax credit carryforwards could expire unused and be unavailable to offset future income tax liabilities, which could adversely affect our profitability.

In addition, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, our ability to utilize net operating loss carryforwards or other tax attributes in any taxable year may be limited if we experience an “ownership change”. A Section 382 “ownership change” generally occurs if one or more stockholders or groups of stockholders who own at least 5% of our stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. Similar rules might apply under state tax laws. This offering or future issuances of our stock could cause an “ownership change”. It is possible that an ownership change, or any future ownership change, could have a material effect on the use of our net operating loss carryforwards or other tax attributes, which could adversely affect our profitability.

We might be unable to adequately protect, and we might incur significant costs in enforcing, our intellectual property and other proprietary rights.

Our success depends in part on our ability to enforce our intellectual property and other proprietary rights. We rely on a combination of trademark, trade secret, copyright, patent, and unfair competition laws, as well as license and access agreements and other contractual provisions, to protect our intellectual property and other proprietary rights. In addition, we attempt to protect our intellectual property and proprietary information by requiring employees and consultants to enter into confidentiality, noncompetition, and assignment of inventions agreements. Our attempts to protect our intellectual property might be challenged by others or invalidated through administrative process or litigation. While we have five U.S. patent applications pending, we might not be able to obtain meaningful patent protection for our software. In addition, if any patents are issued in the future, they might not provide us with any competitive advantages, or might be successfully challenged by third parties. Agreement terms that address non-competition are difficult to enforce in many jurisdictions and might not be enforceable in certain cases. To the extent that our intellectual property and other proprietary rights are not adequately protected, third parties might gain access to our proprietary information, develop and market products or services similar to ours, or use trademarks similar to ours, each of which could materially harm our business. Existing U.S. federal and state intellectual property

 

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laws offer only limited protection. Moreover, the laws of other countries in which we might in the future conduct operations or contract for services might afford little or no effective protection of our intellectual property. The failure to adequately protect our intellectual property and other proprietary rights could materially harm our business.

In addition, if we resort to legal proceedings to enforce our intellectual property rights or to determine the validity and scope of the intellectual property or other proprietary rights of others, the proceedings could be burdensome and expensive, even if we were to prevail. Any litigation that is necessary in the future could result in substantial costs and diversion of resources and could have a material adverse effect on our business, operating results or financial condition.

We might be sued by third parties for alleged infringement of their proprietary rights.

The software and Internet industries are characterized by the existence of a large number of patents, trademarks, and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. We have received in the past, and might receive in the future, communications from third parties claiming that we have infringed the intellectual property rights of others. Our technologies might not be able to withstand any third-party claims or rights against their use. Any intellectual property claims, with or without merit, could be time-consuming and expensive to resolve, divert management attention from executing our business plan, and require us to pay monetary damages or enter into royalty or licensing agreements. In addition, many of our contracts contain warranties with respect to intellectual property rights, and most require us to indemnify our clients for third-party intellectual property infringement claims, which would increase the cost to us of an adverse ruling on such a claim.

Moreover, any settlement or adverse judgment resulting from such a claim could require us to pay substantial amounts of money or obtain a license to continue to use the software or information that is the subject of the claim, or otherwise restrict or prohibit our use of it. We might not be able to obtain a license on commercially reasonable terms, if at all, from third parties asserting an infringement claim; we might not be able to develop alternative technology on a timely basis, if at all; and we might not be able to obtain a license to use a suitable alternative technology to permit us to continue offering, and our clients to continue using, our affected services. Accordingly, an adverse determination could prevent us from offering our services to others.

Failure to adequately expand our direct sales force will impede our growth.

We believe that our future growth will depend on the continued development of our direct sales force and its ability to obtain new customers and to manage our existing customer base. Identifying and recruiting qualified personnel and training them in the use of our software requires significant time, expense, and attention. It can take six months or longer before a new sales representative is fully trained and productive. Our business may be adversely affected if our efforts to expand and train our direct sales force do not generate a corresponding increase in revenues. In particular, if we are unable to hire and develop sufficient numbers of productive direct sales personnel or if new direct sales personnel are unable to achieve desired productivity levels in a reasonable period of time, sales of our products and services will suffer and our growth will be impeded.

Any future litigation against us could be costly and time-consuming to defend.

We may become subject, from time to time, to legal proceedings and claims that arise in the ordinary course of business such as claims brought by our clients in connection with commercial disputes or employment claims made by our current or former associates. Litigation might result in substantial costs and may divert management’s attention and resources, which might seriously harm our business, overall financial condition, and operating results. Insurance might not cover such claims, might not provide sufficient payments to cover all the costs to resolve one or more such claims, and might not continue to be

 

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available on terms acceptable to us. A claim brought against us that is uninsured or underinsured could result in unanticipated costs, thereby reducing our operating results and leading analysts or potential investors to reduce their expectations of our performance, which could reduce the trading price of our stock.

If we acquire companies or technologies in the future, they could prove difficult to integrate, disrupt our business, dilute stockholder value, and adversely affect our operating results and the value of our common stock.

As part of our business strategy, we might acquire, enter into joint ventures with, or make investments in complementary companies, services, and technologies in the future. For example, in 2010, we acquired 100% of the net assets of Beninform Holdings, Inc., including its wholly owned subsidiary Benefit Informatics, Inc., and the intellectual property assets of BeliefNetworks, Inc. We spent considerable time, effort, and money pursuing these companies and successfully integrating them into our business. Acquisitions and investments involve numerous risks, including:

 

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difficulties in identifying and acquiring products, technologies or businesses that will help our business;

 

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difficulties in integrating operations, technologies, services and personnel;

 

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diversion of financial and managerial resources from existing operations;

 

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risk of entering new markets in which we have little to no experience; and

 

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delays in customer purchases due to uncertainty and the inability to maintain relationships with customers of the acquired businesses.

If we fail to properly evaluate acquisitions or investments, we might not achieve the anticipated benefits of any such acquisitions, we might incur costs in excess of what we anticipate, and management resources and attention might be diverted from other necessary or valuable activities.

We might require additional capital to support business growth, and this capital might not be available.

We intend to continue to make investments to support our business growth and might require additional funds to respond to business challenges or opportunities, including the need to develop new products and services or enhance our existing services, enhance our operating infrastructure, and acquire complementary businesses and technologies. Accordingly, we might need to engage in equity or debt financings to secure additional funds. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which might make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. In addition, we might not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.

Future sales to customers outside the United States or with international operations might expose us to risks inherent in international sales which, if realized, could adversely affect our business.

An element of our growth strategy is to expand internationally. Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic,

 

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and political risks that are different from those in the United States. Because of our limited experience with international operations, our international expansion efforts might not be successful in creating demand for our products and services outside of the United States or in effectively selling our solutions in the international markets we enter. In addition, we will face risks in doing business internationally that could adversely affect our business, including:

 

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the need to localize and adapt our solutions for specific countries, including translation into foreign languages and associated expenses;

 

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data privacy laws which require that customer data be stored and processed in a designated territory;

 

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difficulties in staffing and managing foreign operations;

 

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different pricing environments, longer sales cycles and longer accounts receivable payment cycles and collections issues;

 

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new and different sources of competition;

 

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weaker protection for intellectual property and other legal rights than in the United States and practical difficulties in enforcing intellectual property and other rights outside of the United States;

 

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laws and business practices favoring local competitors;

 

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compliance challenges related to the complexity of multiple, conflicting and changing governmental laws and regulations, including employment, tax, privacy, and data protection laws and regulations;

 

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increased financial accounting and reporting burdens and complexities;

 

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restrictions on the transfer of funds;

 

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adverse tax consequences; and

 

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unstable regional economic and political conditions.

If we denominate our international contracts in local currencies, fluctuations in the value of the U.S. dollar and foreign currencies might impact our operating results when translated into U.S. dollars.

Risks Related to Our Products and Services Offerings

If our security measures are breached or fail, and unauthorized persons gain access to customers’ and consumers’ data, our products and services might be perceived as not being secure, customers and consumers might curtail or stop using our products and services, and we might incur significant liabilities.

Our products and services involve the storage and transmission of customers’ and consumers’ confidential information, which may include sensitive individually identifiable information that is subject to stringent legal and regulatory obligations. Because of the sensitivity of this information, security features of our software are very important. If our security measures are breached or fail and/or are bypassed as a result of third-party action, employee error, malfeasance, or otherwise, someone might be able to obtain unauthorized access to our customers’ confidential information and/or patient data. As a result, our reputation could be damaged, our business might suffer, and we could face damages for contract breach, penalties for violation of applicable laws or regulations, and significant costs for remediation and remediation efforts to prevent future occurrences.

In addition, we rely on various third parties, including employers’ HR departments, carriers, and other third-party service providers and consumers themselves, as users of our system for key activities to protect and promote the security of our systems and the data and information accessible within them, such as administration of enrollment, consumer status changes, claims, and billing. On occasion, people

 

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have failed to perform these activities. For example, employers sometimes have failed to terminate the login/password of former employees, or permitted current employees to share login/passwords. When we become aware of such breaches, we work with employers to terminate inappropriate access and provide additional instruction in order to avoid the reoccurrence of such problems. Although to date these breaches have not resulted in claims against us or in material harm to our business, failures to perform these activities might result in claims against us, which could expose us to significant expense, legal liability, and harm to our reputation, which might result in loss of business.

Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we might not be able to anticipate these techniques or to implement adequate preventive measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose sales and customers. In addition, our customers might authorize or enable third parties to access their information and data that is stored on our systems. Because we do not control such access, we cannot ensure the complete integrity or security of such data in our systems.

Failure by our customers to obtain proper permissions and waivers might result in claims against us or may limit or prevent our use of data, which could harm our business.

We require our customers to provide necessary notices and to obtain necessary permissions and waivers for use and disclosure of information on the Benefitfocus platform, and we require contractual assurances from them that they have done so and will do so. If, however, despite these requirements and contractual obligations, our customers do not obtain necessary permissions and waivers, then our use and disclosure of information that we receive from them or on their behalf might be limited or prohibited by state or federal privacy laws or other laws. This could impair our functions, processes and databases that reflect, contain, or are based upon such data and might prevent use of such data. In addition, this could interfere with, or prevent creation or use of, rules, analyses, or other data-driven activities that benefit us and our business. Moreover, we might be subject to claims or liability for use or disclosure of information by reason of lack of valid notices, agreements, permissions or waivers. These claims or liabilities could subject us to unexpected costs and adversely affect our operating results.

Our proprietary software might not operate properly, which could damage our reputation, give rise to claims against us, or divert application of our resources from other purposes, any of which could harm our business and operating results.

Proprietary software development is time-consuming, expensive, and complex. Unforeseen difficulties can arise. We might encounter technical obstacles, and it is possible that we discover problems that prevent our proprietary applications from operating properly. If they do not function reliably or fail to achieve customer expectations in terms of performance, customers could assert liability claims against us and/or attempt to cancel their contracts with us. This could damage our reputation and impair our ability to attract or maintain customers.

Moreover, benefits management software as complex as ours has in the past contained, and may in the future contain, or develop, undetected defects or errors. Material performance problems or defects in our products and services might arise in the future. Errors might result from the interface of our services with legacy systems and data, which we did not develop and the function of which is outside of our control. Defects or errors might arise in our existing or new software or service processes. Because changes in employer, carrier, and legal requirements and practices relating to benefits are frequent, we are continuously discovering defects and errors in our software and service processes compared against these requirements and practices. These defects and errors and any

 

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failure by us to identify and address them could result in loss of revenue or market share, liability to customers or others, failure to achieve market acceptance or expansion, diversion of development and other resources, injury to our reputation, and increased service and maintenance costs. Defects or errors in our product or service processes might discourage existing or potential customers from purchasing services from us. Correction of defects or errors could prove to be impossible or impracticable. The costs incurred in correcting any defects or errors or in responding to resulting claims or liability might be substantial and could adversely affect our operating results.

In addition, customers that rely on our products and services to collect, manage, and report benefits data might have a greater sensitivity to service errors and security vulnerabilities than customers of software products in general. We market and sell services that, among other things, provide information to assist care providers in tracking and treating ill patients. Any operational delay in or failure of our software service processes might result in the disruption of patient care and could cause harm to our business and operating results.

Our customers might assert claims against us in the future alleging that they suffered damages due to a defect, error, or other failure of our product or service processes. A product liability claim or errors or omissions claim could subject us to significant legal defense costs and adverse publicity regardless of the merits or eventual outcome of such a claim.

Various events could interrupt customers’ access to the Benefitfocus platform, exposing us to significant costs.

The ability to access the Benefitfocus platform is critical to our customers. Our operations and facilities are vulnerable to interruption and/or damage from a number of sources, many of which are beyond our control, including, without limitation: (i) power loss and telecommunications failures, (ii) fire, flood, hurricane, and other natural disasters, (iii) software and hardware errors, failures or crashes in our own systems or in other systems, (iv) computer viruses, denial-of-service attacks, hacking and similar disruptive problems in our own systems and in other systems, and (v) civil unrest, war, and/or terrorism. We have implemented various measures to protect against interruptions of customers’ access to our platform. If customers’ access is interrupted because of problems in the operation of our facilities, we could be exposed to significant claims by customers, particularly if the access interruption is associated with problems in the timely delivery of funds due to customers or medical information relevant to patient care. Our plans for disaster recovery and business continuity rely on third-party providers of related services. If those vendors fail us at a time when our systems are not operating correctly, we could incur a loss of revenue and liability for failure to fulfill our obligations. Any significant instances of system downtime could negatively affect our reputation and ability to retain customers and sell our services, which would adversely impact our revenue.

In addition, retention and availability of patient care and physician reimbursement data are subject to federal and state laws governing record retention, accuracy, and access. Some laws impose obligations on our customers and on us to produce information for third parties and to amend or expunge data at their direction. Our failure to meet these obligations might result in liability, which could increase our costs and reduce our operating results.

We rely on data center providers, Internet infrastructure, bandwidth providers, third-party computer hardware and software, other third parties, and our own systems for providing services to our customers, and any failure or interruption in the services provided by these third parties or our own systems could expose us to litigation and negatively impact our relationships with customers, adversely affecting our brand and our business.

We serve all our customers from two data centers, one located in Raleigh, North Carolina and the other located in Charlotte, North Carolina. While we control and have access to our servers, we do not

 

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control the operation of these facilities. The owners of our data center facilities have no obligation to renew their agreements with us on commercially reasonable terms, or at all. If we are unable to renew these agreements on commercially reasonable terms, or if one of our data center operators is acquired, we may be required to transfer our servers and other infrastructure to new data center facilities, and we may incur significant costs and possible service interruption in connection with doing so. Problems faced by our third-party data center locations, with the telecommunications network providers with whom we or they contract, or with the systems by which our telecommunications providers allocate capacity among their customers, including us, could adversely affect the experience of our customers. Our third-party data centers operators could decide to close their facilities without adequate notice. In addition, any financial difficulties, such as bankruptcy faced by our third-party data centers operators or any of the service providers with whom we or they contract may have negative effects on our business, the nature and extent of which are difficult to predict.

In addition, our ability to deliver our web-based services depends on the development and maintenance of the infrastructure of the Internet by third parties. This includes maintenance of a reliable network backbone with the necessary speed, data capacity, bandwidth capacity, and security. Our services are designed to operate without interruption in accordance with our service level commitments. However, we have experienced and expect that we will experience future interruptions and delays in services and availability from time to time. We do not maintain redundant systems for all of our services. In the event of a catastrophic event with respect to one or more of our systems, we may experience an extended period of system unavailability, which could negatively impact our relationship with customers. To operate without interruption, both we and our service providers must guard against:

 

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damage from fire, power loss, natural disasters and other force majeure events outside our control;

 

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communications failures;

 

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software and hardware errors, failures, and crashes;

 

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security breaches, computer viruses, hacking, denial-of-service attacks, and similar disruptive problems; and

 

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other potential interruptions.

We also rely on computer hardware purchased or leased and software licensed from third parties in order to offer our services, including software from Oracle Corporation and Microsoft Corporation, and routers and network equipment from Cisco and Hewlett-Packard Company. These licenses are generally commercially available on varying terms. However, it is possible that this hardware and software might not continue to be available on commercially reasonable terms, or at all. Any loss of the right to use any of this hardware or software could result in delays in the provisioning of our services until equivalent technology is either developed by us, or, if available, is identified, obtained and integrated.

We exercise limited control over third-party vendors, which increases our vulnerability to problems with technology and information services they provide. Interruptions in our network access and services might in connection with third-party technology and information services reduce our revenue, cause us to issue refunds to customers for prepaid and unused subscription services, subject us to potential liability, or adversely affect our renewal rates. Although we maintain insurance for our business, the coverage under our policies might not be adequate to compensate us for all losses that may occur. In addition, we might not be able to continue to obtain adequate insurance coverage at an acceptable cost, if at all.

 

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The use of open source software in our products and solutions may expose us to additional risks and harm our intellectual property rights.

Some of our products and solutions use or incorporate software that is subject to one or more open source licenses. Open source software is typically freely accessible, usable, and modifiable. Certain open source software licenses require a user who intends to distribute the open source software as a component of the user’s software to disclose publicly part or all of the source code to the user’s software. In addition, certain open source software licenses require the user of such software to make any derivative works of the open source code available to others on potentially unfavorable terms or at no cost.

The terms of many open source licenses to which we are subject have not been interpreted by U.S. or foreign courts. Accordingly, there is a risk that those licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to commercialize our solutions. In that event, we could be required to seek licenses from third parties in order to continue offering our products or solutions, to re-develop our products or solutions, to discontinue sales of our products or solutions, or to release our proprietary software code under the terms of an open source license, any of which could harm our business. Further, given the nature of open source software, it may be more likely that third parties might assert copyright and other intellectual property infringement claims against us based on our use of these open source software programs.

While we monitor the use of all open source software in our products, solutions, processes, and technology and try to ensure that no open source software is used in such a way as to require us to disclose the source code to the related product or solution when we do not wish to do so, it is possible that such use may have inadvertently occurred in deploying our proprietary solutions. In addition, if a third-party software provider has incorporated certain types of open source software into software we license from such third party for our products and solutions without our knowledge, we could, under certain circumstances, be required to disclose the source code to our products and solutions. This could harm our intellectual property position and our business, results of operations, and financial condition.

Risks Related to Regulation

Government regulation of the areas in which we operate creates risks and challenges with respect to our compliance efforts and our business strategies.

The employee benefits industry is highly regulated and is subject to changing political, legislative, regulatory, and other influences. Existing and new laws and regulations affecting the employee benefits industry could create unexpected liabilities for us, cause us to incur additional costs and restrict our operations. These laws and regulations are complex and their application to specific services and relationships are not clear. In particular, many existing laws and regulations affecting employee benefits, when enacted, did not anticipate the services that we provide, and these laws and regulations might be applied to our services in ways that we do not anticipate. Our failure to accurately anticipate the application of these laws and regulations, or our failure to comply, could create liability for us, result in adverse publicity, and negatively affect our business. Some of the risks we face from the regulation of employee benefits are as follows:

 

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Although numerous lawsuits challenged the constitutionality of the Patient Protection and Affordable Care Act, or PPACA, the U.S. Supreme Court on June 28, 2012, upheld the constitutionality of PPACA except for provisions that would have allowed the U.S. Department of Health and Human Services, or HHS, to penalize states that did not implement the Medicaid expansion with the loss of existing federal Medicaid funding. While many of the provisions of PPACA will not be directly applicable to us, PPACA, as enacted, might affect the business of many of our customers. Carriers and large employers might experience changes in the numbers of individuals they insure as a result of Medicaid expansion and the creation of state

 

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and national exchanges, though it is unclear how many states will decline to implement the Medicaid expansion or adopt state-specific exchanges. Although we are unable to predict with any reasonable certainty or otherwise quantify the likely impact of PPACA on our business model, financial condition, or results of operations, changes in the business of our customers and the number of individuals they insure may negatively impact our business.

 

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False or Fraudulent Claim Laws .    There are numerous federal and state laws that forbid submission of false information or the failure to disclose information in connection with submission and payment of claims for reimbursement from the government. In some cases, these laws also forbid abuse of existing systems for such submission and payment. Although our business operations are generally not subject to these laws and regulations, any contract we have with a government entity requires us to comply with these laws and regulations. Any failure of our services to comply with these laws and regulations could result in substantial liability, including but not limited to criminal liability, could adversely affect demand for our services, and could force us to expend significant capital, research and development, and other resources to address the failure. Any determination by a court or regulatory agency that our services with government clients violate these laws and regulations could subject us to civil or criminal penalties, invalidate all or portions of some of our government client contracts, require us to change or terminate some portions of our business, require us to refund portions of our services fees, cause us to be disqualified from serving not only government clients but also all clients doing business with government payers, and have an adverse effect on our business.

 

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HIPAA and Other Privacy and Security Requirements .    There are numerous U.S. federal and state laws and regulations related to the privacy and security of personal health information. In particular, regulations promulgated pursuant to the Health Insurance Portability and Accountability Act of 1996, or HIPAA, established privacy and security standards that limit the use and disclosure of individually identifiable health information, and require the implementation of administrative, physical, and technological safeguards to ensure the confidentiality, integrity, and availability of individually identifiable health information in electronic form. Health plans, healthcare clearinghouses, and most providers are considered by the HIPAA regulations to be “Covered Entities”. With respect to our operations as a healthcare clearinghouse, we are directly subject to the privacy regulations established under HIPAA, or Privacy Standards, and the security regulations established under HIPAA, or Security Standards. In addition, our carrier customers, or payors, are considered to be Covered Entities and are required to enter into written agreements with us, known as Business Associate Agreements, under which we are considered to be a “Business Associate” and that require us to safeguard individually identifiable health information and restrict how we may use and disclose such information. Effective February 2010, the American Recovery and Reinvestment Act of 2009, or ARRA, and effective March 2013, the HIPAA Omnibus Final Rules extended the direct application of certain provisions of the Privacy Standards and Security Standards to us when we are functioning as a Business Associate of our carrier customers. ARRA and the HIPAA Omnibus Final Rule also subject Business Associates to direct oversight and audit by the HHS.

Violations of the Privacy Standards and Security Standards might result in civil and criminal penalties, and ARRA increased the penalties for HIPAA violations and strengthened the enforcement provisions of HIPAA. For example, ARRA authorizes state attorneys general to bring civil actions seeking either injunctions or damages in response to violations of Privacy Standards and Security Standards that threaten the privacy of state residents.

We might not be able to adequately address the business risks created by HIPAA implementation. Furthermore, we are unable to predict what changes to HIPAA or other laws or regulations might be made in the future or how those changes could affect our business or the costs of compliance.

 

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Some payors and clearinghouses interpret HIPAA transaction requirements differently than we do. Where payors or clearinghouses require conformity with their interpretations as a condition of a successful transaction, we seek to comply with their interpretations.

In addition to the Privacy Standards and Security Standards, most states have enacted patient confidentiality laws that protect against the disclosure of confidential medical and/or health information, and many states have adopted or are considering further legislation in this area, including privacy safeguards, security standards, and data security breach notification requirements. Such state laws, if more stringent than HIPAA requirements, are not preempted by the federal requirements and we are required to comply with them.

Failure by us to comply with any state standards regarding patient privacy may subject us to penalties, including civil monetary penalties and, in some circumstances, criminal penalties. Such failure may injure our reputation and adversely affect our ability to retain customers and attract new customers.

 

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Medicare and Medicaid Regulatory Requirements .    We have contracts with insurance carriers who offer Medicare Managed Care (also known as Medicare Advantage or Medicare Part C) and Medicaid Managed Care benefits plans. We also have contracts with insurance carriers who offer Medicare prescription drug benefits (also known as Medicare Part D) plans. The activities of the Medicare plans are regulated by the Centers for Medicare & Medicaid Services, or CMS, the federal agency that provides oversight of the Medicare and Medicaid programs. The Medicaid Managed Care plans are regulated by both CMS and the individual states where the plans are offered. Some of the activities that we might perform, such as the enrollment of beneficiaries, may be subject to CMS and/or state regulation, and such regulations may force us to change the way we do business or otherwise restrict our ability to provide services to such plans. Moreover, the regulatory environment with respect to these programs has become, and will likely continue to become, increasingly complex.

 

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Financial Services-Related Laws and Rules .    Financial services and electronic payment processing services are subject to numerous laws, regulations and industry standards, some of which might impact our operations and subject us, our vendors, and our customers to liability as a result of the payment distribution and processing solutions we offer. Although we do not act as a bank, we offer solutions that involve banks, or vendors who contract with banks and other regulated providers of financial services. As a result, we might be impacted by banking and financial services industry laws, regulations, and industry standards, such as licensing requirements, solvency standards, requirements to maintain the privacy and security of nonpublic personal financial information, and Federal Deposit Insurance Corporation deposit insurance limits. In addition, our patient billing and payment distribution and processing solutions might be impacted by payment card association operating rules, certification requirements, and rules governing electronic funds transfers. If we fail to comply with applicable payment processing rules or requirements, we might be subject to fines and changes in transaction fees and may lose our ability to process credit and debit card transactions or facilitate other types of billing and payment solutions. Moreover, payment transactions processed using the Automated Clearing House Network, or ACH, are subject to network operating rules promulgated by the National Automated Clearing House Association and to various federal laws regarding such operations, including laws pertaining to electronic funds transfers, and these rules and laws might impact our billing and payment solutions. Further, our solutions might impact the ability of our payor customers to comply with state prompt payment laws. These laws require payors to pay healthcare claims meeting the statutory or regulatory definition of a “clean claim” within a specified time frame.

 

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Insurance Broker Laws .    Insurance laws in the United States are often complex, and states have broad authority to adopt regulations regarding brokerage activities. These regulations typically include the licensing of insurance brokers and agents and govern the handling and

 

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investment of client funds held in a fiduciary capacity. Although we believe our activities do not currently constitute the provision of insurance brokerage services, regulations may change from state to state, which could require us to comply with such expanded regulations.

 

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ERISA .    The Employee Retirement Income Security Act of 1974, as amended, or ERISA, regulates how employee benefits are provided to or through certain types of employer-sponsored health benefits plans. ERISA is a set of laws and regulations that is subject to periodic interpretation by the U.S. Department of Labor as well as the federal courts. In some circumstances, and under certain customer contracts, we might be deemed to have assumed duties that make us an ERISA fiduciary, and thus be required to carry out our operations in a manner that complies with ERISA in all material respects. We believe that our current operations do not render us subject to ERISA fiduciary obligations, and therefore that we are in material compliance with ERISA and that any such compliance does not currently have a material adverse effect on our operations. However, there can be no assurance that continuing ERISA compliance efforts or any future changes to ERISA will not have a material adverse effect on us.

 

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Third-Party Administrator Laws .    Numerous states in which we do business have adopted regulations governing entities engaged in third-party administrator, or TPA, activities. TPA regulations typically impose requirements regarding enrollment into benefits plans, claims processing and payments, and the handling of customer funds. Although we do not believe we are currently acting as a TPA, changes in state regulations could result in us being obligated to comply with such regulations, which might require us to obtain licenses to provide TPA services in such states.

We are subject to banking regulations that may limit our business activities.

The Goldman Sachs Group, affiliates of which will own         % of the voting and economic interest in our business immediately after consummation of this offering (assuming no exercise of the underwriters’ option to purchase additional shares and no exercise of outstanding options or warrants after                     , 2013), is regulated as a bank holding company and a financial holding company under the Bank Holding Company Act of 1956, as amended, or the BHC Act. The BHC Act imposes regulations and requirements on The Goldman Sachs Group and on any company that is deemed to be controlled by The Goldman Sachs Group under the BHC Act and the regulations of the Board of Governors of the Federal Reserve System, or the Federal Reserve. Due to the size of its voting and economic interest, we are deemed to be controlled by The Goldman Sachs Group and are therefore considered to be a “subsidiary” of The Goldman Sachs Group under the BHC Act. We will remain subject to this regulatory regime until The Goldman Sachs Group is no longer deemed to control us for purposes of the BHC Act, which we do not generally have the ability to control and which will not occur until The Goldman Sachs Group has significantly reduced its voting and economic interest in us.

As a controlled subsidiary of The Goldman Sachs Group, we are restricted from engaging in activities that are not permissible under the BHC Act, or the rules and regulations promulgated thereunder. Permitted activities for a bank holding company or any controlled subsidiary generally include activities that the Federal Reserve has previously determined to be closely related to banking, financial in nature or incidental or complementary to financial activities, including data processing services such as those that we provide with our software solutions. Further, as a result of being subject to regulation and supervision by the Federal Reserve, we may be required to obtain the prior approval of the Federal Reserve before engaging in certain new activities or businesses, whether organically or by acquisition. The Federal Reserve could exercise its power to restrict us from engaging in any activity that, in the Federal Reserve’s opinion, is unauthorized or constitutes an unsafe or unsound business practice. To the extent that these regulations impose limitations on our business, we could be at a competitive disadvantage because some of our competitors are not subject to these limitations.

 

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As a subsidiary of a bank holding company, we are subject to examination by the Federal Reserve and required to provide information and reports for use by the Federal Reserve under the BHC Act. In addition, we may be subject to regulatory oversight and examination because we are a technology service provider to regulated financial institutions. Further, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act, and related financial regulatory reform calls for the issuance of numerous regulations designed to increase and strengthen the regulation of bank holding companies, including The Goldman Sachs Group and its affiliates. We cannot predict the impact of this new regulatory regime on our business with certainty.

Because of The Goldman Sachs Group’s status as a bank holding company, we have agreed to certain covenants for the benefit of The Goldman Sachs Group that are intended to facilitate its compliance with the BHC Act and that may impose certain obligations on the Company. For a discussion of these covenants, see “Certain Relationships and Related Party Transactions—Corporate Governance.” Furthermore, additional restrictions placed on The Goldman Sachs Group as a result of supervisory or enforcement actions may restrict us or our activities in certain circumstances, even if these actions are unrelated to our conduct or business.

For further discussion of the applicability of banking regulation to our business and the risks presented by such regulation, see “Business—Government Regulation—Banking Regulation.”

Potential regulatory requirements placed on our software, services, and content could impose increased costs on us, delay or prevent our introduction of new service types, and impair the function or value of our existing service types.

Our products and services are and are likely to continue to be subject to increasing regulatory requirements in a number of ways. As these requirements proliferate, we must change or adapt our products and services to comply. Changing regulatory requirements might render our services obsolete or might block us from accomplishing our work or from developing new services. This might in turn impose additional costs upon us to comply or to further develop our products and services. It might also make introduction of new product or service types more costly or more time-consuming than we currently anticipate. It might even prevent introduction by us of new products or services or cause the continuation of our existing products or services to become unprofitable or impossible.

Potential government subsidy of services similar to ours, or creation of a single payor system, might reduce customer demand.

Recently, entities including brokers and U.S. federal and state governments have offered to subsidize adoption of online benefits platforms or clearinghouses. In addition, federal regulations have been changed to permit such subsidy from additional sources subject to certain limitations. To the extent that we do not qualify or participate in such subsidy programs, demand for our services might be reduced, which may decrease our revenue. In addition, prior proposals regarding healthcare reform have included the concept of creation of a single payor for healthcare insurance. This kind of consolidation of critical benefits activity could negatively impact the demand for our services.

Our services present the potential for embezzlement, identity theft, or other similar illegal behavior by our associates with respect to third parties.

Among other things, certain services offered by us involve collecting payment information from individuals, and this frequently includes check and credit card information. Even though we do not handle direct payments, our services also involve the use and disclosure of personal and business information that could be used to impersonate third parties, commit identity theft, or otherwise gain access to their data or funds. If any of our associates take, convert, or misuse such funds, documents,

 

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or data, we could be liable for damages, and our business reputation could be damaged or destroyed. Moreover, if we fail to adequately prevent third parties from accessing personal and/or business information and using that information to commit identity theft, we might face legal liabilities and other losses than can have a negative impact on our business.

Risks Related to this Offering and Ownership of Our Common Stock

An active, liquid, and orderly market for our common stock may not develop.

Prior to this offering, there was no market for shares of our common stock. An active trading market for our common stock might never develop or be sustained, which could depress the market price of our common stock and affect your ability to sell our shares. The initial public offering price will be determined through negotiations between us and the representatives of the underwriters and might bear no relationship to the price at which our common stock will trade following the completion of this offering. The trading price of our common stock following this offering is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include:

 

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our operating performance and the operating performance of similar companies;

 

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the overall performance of the equity markets;

 

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announcements by us or our competitors of acquisitions, business plans, or commercial relationships;

 

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threatened or actual litigation;

 

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changes in laws or regulations relating to the sale of health insurance;

 

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any major change in our board of directors or management;

 

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publication of research reports or news stories about us, our competitors, or our industry, or positive or negative recommendations or withdrawal of research coverage by securities analysts;

 

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large volumes of sales of our shares of common stock by existing stockholders; and

 

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general political and economic conditions.

In addition, the stock market in general, and the market for Internet-related companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These fluctuations might be even more pronounced in the trading market for our stock shortly following this offering. Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. This litigation, if instituted against us, could result in substantial costs, divert our management’s attention and resources, and harm our business, operating results, and financial condition.

We do not currently intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We have never declared or paid any cash dividends on our common stock and do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future, and the success of an investment in shares of our common stock will depend upon future appreciation in its value, if any. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders purchased their shares.

 

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Future sales of shares of our common stock by existing stockholders could depress the market price of our common stock.

Upon completion of this offering, there will be              shares of our common stock outstanding (or              shares, if the underwriters exercise in full their option to purchase additional shares). The              shares being sold in this offering will be freely tradeable immediately after this offering (except for shares purchased by affiliates) and of the 21,312,049 shares outstanding on a pro forma basis as of June 30, 2013 (assuming no exercise of outstanding options or warrants after June 30, 2013),              shares are freely tradable shares under Rule 144 that are not subject to a lock-up,              shares may be sold upon expiration of lock-up agreements 180 days after the date of this offering (subject in some cases to volume limitations). In addition, as of June 30, 2013, there were outstanding options and a warrant to purchase 3,743,356 shares of our common stock that, if exercised, will result in these additional shares becoming available for sale upon expiration of the lock-up agreements. A large portion of these shares and options are held by a small number of persons and investment funds. Sales by these stockholders or option holders of a substantial number of shares after this offering could significantly reduce the market price of our common stock. Moreover, after this offering, some holders of shares of common stock will have rights, subject to some conditions, to require us to file registration statements covering the shares they currently hold, or to include these shares in registration statements that we might file for ourselves or other stockholders.

We also intend to register all common stock that we may issue under our stock plans. Effective upon the completion of this offering, an aggregate of              shares of our common stock will be reserved for future issuance under these plans. Once we register these shares, which we plan to do shortly after the completion of this offering, they can be freely sold in the public market upon issuance, subject to the lock-up agreements referred to above. If a large number of these shares are sold in the public market, the sales could reduce the trading price of our common stock. See “Shares Eligible for Future Sale” for a more detailed description of sales that may occur in the future.

You will experience immediate and substantial dilution.

The initial public offering price will be substantially higher than the net tangible book value of each outstanding share of common stock immediately after this offering. If you purchase common stock in this offering, you will suffer immediate and substantial dilution. At an assumed initial public offering price of $         with net proceeds to the Company of $         million, after deducting estimated underwriting discounts and commissions and estimated offering expenses, investors who purchase shares in this offering will have contributed approximately     % of the total amount of funding we have received to date, but will only hold approximately     % of the total voting rights. The dilution will be $         per share in the net tangible book value of the common stock from the assumed initial public offering price. In addition, if outstanding options or warrants to purchase shares of our common stock are exercised, there could be further dilution. For more information refer to “Dilution”.

We have broad discretion in the use of the net proceeds from this offering and might not use them effectively.

We cannot specify with certainty the particular uses of the net proceeds we will receive from this offering. Our management will have broad discretion in the application of the net proceeds, including for any of the purposes described in “Use of Proceeds”. Accordingly, you will have to rely on the judgment of our management with respect to the use of the proceeds, with only limited information concerning management’s specific intentions. Our management might spend a portion or all of the net proceeds from this offering in ways that our stockholders do not desire or that might not yield a favorable return. The failure by our management to apply these funds effectively could harm our business. Pending their use, we might invest the net proceeds from this offering in a manner that does not produce income or that loses value.

 

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A limited number of stockholders will have the ability to influence the outcome of director elections and other matters requiring stockholder approval.

After this offering, our directors, executive officers, and their affiliated entities will beneficially own more than     % of our outstanding common stock (assuming no exercise of the underwriters’ option to purchase additional shares and no exercise of outstanding options or warrants after                     , 2013). Additionally, after this offering, GS Capital Partners VI Parallel, L.P., GS Capital Partners VI Offshore Fund, L.P., GS Capital Partners VI Fund, L.P., and GS Capital Partners VI GmbH & CO. KG, which are affiliates of Goldman, Sachs & Co. and which we refer to as the Goldman Funds, collectively will beneficially own approximately     % (assuming no exercise of the underwriters’ option to purchase additional shares and no exercise of outstanding options or warrants after             , 2013). These stockholders, if they act together, could exert substantial influence over matters requiring approval by our stockholders, including the amendment of our amended and restated certificate of incorporation and amended and restated bylaws, and the approval of mergers or other business combination transactions. For example, our amended and restated bylaws provide that so long as The Goldman Sachs Group, Inc. and its affiliates own, collectively, at least 35% of our common stock, we may not amend, without the written consent of the Goldman Sachs Group, provisions in our amended and restated certificate of incorporation or our amended and restated bylaws related to the ability of our stockholders to act by written consent, the procedures by which our stockholders may call a special meeting of stockholders, and the classification of our board of directors into three classes.

Additionally, the Goldman Funds, Oak Investment Partners XII, L.P., Mason R. Holland, Jr., our Executive Chairman and a director, and Shawn A. Jenkins, our President and Chief Executive Officer and a director, entered into a voting agreement for the election of directors. After this offering, these stockholders will collectively beneficially own more than         % of our common stock. Pursuant to the voting agreement, the parties agree to vote all of their shares to elect two directors nominated by the Goldman Funds, one director nominated by Oak Investment Partners, and each of Messrs. Holland and Jenkins to our board of directors. As a result, these stockholders will have significant influence on the outcome of director elections. This concentration of ownership might discourage, delay, or prevent a change in control of our company, which could deprive our stockholders of an opportunity to receive a premium for their stock as part of a sale of our company and might reduce our stock price. These actions may be taken even if they are opposed by other stockholders, including those who purchase shares in this offering.

Following the offering, we will be a “controlled company” within the meaning of the NASDAQ Stock Market listing rules, and we intend to take advantage of exemptions from certain corporate governance requirements.

Following this offering, approximately         % of the voting power of our outstanding common stock (assuming no exercise of the underwriters’ option to purchase additional shares and no exercise of outstanding options or warrants after                     , 2013) will be beneficially owned by a group of our significant stockholders consisting of Oak Investment Partners XII, L.P., the Goldman Funds, and Messrs. Holland and Jenkins. Under the NASDAQ Stock Market listing rules, a company of which more than 50% of the voting power is held by an individual, group or another company is a “controlled company” and is exempt from certain corporate governance requirements, including the requirement that a majority of our directors be independent, as defined in the NASDAQ Stock Market listing rules, and the requirement that our compensation and nominating and corporate governance committees consist entirely of independent directors. Following this offering, we intend to rely on the “controlled company” exemption under the NASDAQ Stock Market listing rules. As a result, a majority of the members of our board of directors may not be independent directors and our nominating and corporate governance and compensation committees will not consist entirely of independent directors. Accordingly, while we remain a controlled company and during any transition period following a time when we are no longer a controlled company, you will not have the same protections afforded to

 

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stockholders of companies that are subject to all of the NASDAQ Stock Market’s corporate governance requirements.

Affiliates of Goldman, Sachs & Co., the lead underwriter in this offering, hold a controlling equity interest in our company, which could expose us to risks associated with Goldman’s conflict of interest.

A controlling equity interest in our company is held in the aggregate by the Goldman Funds, each of which is affiliated with Goldman, Sachs & Co., the lead underwriter in this offering. The Goldman Funds hold the following equity securities: (i) 1,804,202 shares of our Series A Preferred Stock are held directly by GS Capital Partners VI Parallel, L.P., (ii) 5,457,326 shares of our Series A Preferred Stock are held directly by GS Capital Partners VI Offshore Fund, L.P., (iii) 6,561,140 shares of our Series A Preferred Stock are held directly by GS Capital Partners VI Fund, L.P., and (iv) 233,183 shares of our Series A Preferred Stock are held directly by GS Capital Partners VI GmbH & CO. KG. Consequently, Goldman, Sachs & Co. has a conflict of interest within the meaning of Rule 5121 of the FINRA Rules.

Pursuant to Rule 5121, Deutsche Bank Securities Inc. is serving as the “qualified independent underwriter,” as defined by FINRA. Although Deutsche Bank Securities Inc. has, in its capacity as qualified independent underwriter, performed due diligence investigations and reviewed and participated in the preparation of the registration statement of which this prospectus forms a part, we cannot assure you that this will adequately address any potential conflicts of interest. See “Underwriting (Conflicts of Interest)”. In addition, we have agreed to indemnify Deutsche Bank Securities Inc. for acting as qualified independent underwriter against certain liabilities, including liabilities under the Securities Act, and to contribute to payments that Deutsche Bank Securities Inc. may be required to make for those liabilities.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law might discourage, delay, or prevent a change in control of our company or changes in our management and, therefore, depress the trading price of our common stock.

Provisions of our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law might discourage, delay, or prevent a merger, acquisition, or other change in control that stockholders consider favorable, including transactions in which you might otherwise receive a premium for your shares of our common stock. These provisions might also prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions include:

 

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limitations on the removal of directors;

 

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advance notice requirements for stockholder proposals and nominations;

 

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limitations on the ability of stockholders to call special meetings;

 

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if the Goldman Sachs Group and its affiliates cease to own at least 35% of our voting equity, the inability of stockholders to act by written consent;

 

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the inability of stockholders to cumulate votes at any election of directors;

 

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the classification of our board of directors into three classes with only one class, representing approximately one-third of our directors, standing for election at each annual meeting; and

 

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the ability of our board of directors to make, alter or repeal our amended and restated bylaws.

Our board of directors has the ability to designate the terms of and issue new series of preferred stock without stockholder approval. In addition, Section 203 of the Delaware General Corporation Law prohibits a publicly held Delaware corporation from engaging in a business combination with an

 

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interested stockholder, generally a person which together with its affiliates owns, or within the last three years has owned, 15% of our voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner.

The existence of the foregoing provisions and anti-takeover measures could limit the price that investors are willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that you could receive a premium for your common stock in an acquisition.

Our business is subject to changing regulations regarding corporate governance, disclosure controls, internal control over financial reporting, and other compliance areas that will increase both our costs and the risk of noncompliance.

As a public company, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, and the rules and regulations of our stock exchange. The requirements of these rules and regulations will increase our legal, accounting, and financial compliance costs, will make some activities more difficult, time-consuming, and costly, and may also place undue strain on our personnel, systems, and resources.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. Commencing with our fiscal year ending December 31, 2014, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our compliance with Section 404 of the Sarbanes-Oxley Act will require that we incur substantial accounting expense and expend significant management efforts. Prior to this offering, we have never been required to test our internal controls within a specified period, and, as a result, we may experience difficulty in meeting these reporting requirements in a timely manner.

We will be required to disclose changes made to our internal control and procedures on a quarterly basis. However, our independent registered public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act until the later of the year following our first annual report required to be filed with the Securities and Exchange Commission, or SEC, or the date we are no longer an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, if we take advantage of the exemption available under the JOBS Act to the auditor attestation requirement in Section 404(b) of the Sarbanes-Oxley Act. If we are not able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner, the market price of our stock could decline and we could be subject to sanctions or investigations by the stock exchange on which our common stock is listed, the SEC, or other regulatory authorities, which would require additional financial and management resources.

We identified a material weakness in connection with preparation of our 2012 financial statements, and failure to develop and maintain adequate financial controls could cause us to have additional material weaknesses, which could adversely affect our operations and financial position.

In connection with the preparation of our consolidated financial statements for the years ended December 31, 2011 and 2012, we identified a material weakness in our accounting for certain deferred revenue balances and the related revenue recognition. This material weakness arose in connection

 

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with increasing the estimated expected life of our customer relationships, which results in extending the term over which we recognize deferred revenue. A material weakness is a significant deficiency, or a combination of significant deficiencies, in internal control over financial reporting such that it is reasonably possible that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. Our material weakness pertained to deficiencies in our accounting documentation, lack of segregation of duties, and lack of adequate review and monitoring procedures within our accounting for certain deferred revenue balances and the related revenue recognition. Our management has taken steps to remediate this material weakness, including hiring experienced associates and external resources to assist with our revenue recognition function, enhancing the level of documentation required to support key assumptions and conclusions, and redesigning certain monitoring controls critical to ensuring the accuracy of our deferred revenue balances and the related revenue recognition. While we believe that the steps taken to date have remediated the deficiencies that gave rise to the material weakness, and we plan to hire additional experienced associates within our revenue recognition function to further enhance our procedures and controls, there can be no assurances in this regard.

The remedial policies and procedures we have implemented and the additional associates we intend to hire may be insufficient to address the identified material weakness, or we may in the future discover additional weaknesses that require remediation. In addition, an internal control system, no matter how well-designed, cannot provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud will be detected. If we are not able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner, or if we are unable to maintain proper and effective internal controls, we might not be able to produce timely and accurate financial statements. If that were to happen, the market price of our stock could decline and we could be subject to sanctions or investigations by the stock exchange on which our common stock is listed, the Securities and Exchange Commission, or SEC, or other regulatory authorities.

Any failure to develop or maintain effective controls, or any difficulties encountered in their implementation or improvement, could harm our operating results or cause us to fail to meet our reporting obligations. Any failure to implement and maintain effective internal controls also could adversely affect the results of periodic management evaluations regarding the effectiveness of our internal control over financial reporting that we will be required to include in our periodic reports filed with the SEC, beginning for our fiscal year ending December 31, 2014 under Section 404 of the Sarbanes-Oxley Act. Ineffective disclosure controls and procedures or internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of our common stock. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors, officers, and employees, entail substantial costs in order to modify our existing accounting systems, and take a significant period of time to complete. Such changes may not be effective, however, in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In the event that we are not able to demonstrate compliance with Section 404 of the Sarbanes-Oxley Act in a timely manner, that our internal controls are perceived as inadequate, or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results and our stock price could decline.

 

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We are an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an emerging growth company. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

For as long as we continue to be an emerging growth company, we intend to take advantage of certain other exemptions from various reporting requirements that are applicable to other public companies including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved, and exemptions from the requirements of auditor attestation reports on the effectiveness of our internal control over financial reporting. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

We will remain an emerging growth company until the earliest of (i) the end of the fiscal year in which the market value of our common stock that is held by non-affiliates exceeds $700 million as of June 30 of that fiscal year, (ii) the end of the fiscal year in which we have total annual gross revenue of $1 billion or more during such fiscal year, (iii) the date on which we issue more than $1 billion in non-convertible debt in a three-year period, or (iv) five years from the date of this prospectus.

If securities or industry analysts do not publish research or reports about our business, or publish inaccurate or unfavorable research or reports about our business, our stock price and trading volume could decline.

The trading market for our common stock will, to some extent, depend on the research and reports that securities or industry analysts publish about us and our business. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our common stock or change their opinion of our common stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this prospectus regarding our strategy, future operations, future financial position, future revenue, projected costs, prospects, plans, objectives of management, and expected market growth are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “predict,” “project,” “will,” “would,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These forward-looking statements include, among other things, statements about:

 

  Ÿ  

our ability to attract and retain customers;

 

  Ÿ  

our financial performance;

 

  Ÿ  

the advantages of our solutions as compared to those of others;

 

  Ÿ  

our ability to establish and maintain intellectual property rights;

 

  Ÿ  

our ability to retain and hire necessary associates and appropriately staff our operations; and

 

  Ÿ  

our estimates regarding capital requirements and needs for additional financing.

We might not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions, and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements included in this prospectus, particularly in the “Risk Factors” section, which could cause actual results or events to differ materially from the forward-looking statements that we make.

You should read this prospectus and the documents that we have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We do not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

INDUSTRY AND MARKET DATA

Unless otherwise indicated, information contained in this prospectus concerning our industry and the market in which we operate, including our general expectations and market position, market opportunity, and market size, is based on information from various sources, on assumptions that we have made that are based on those data and other similar sources, and on our knowledge of the markets for our products. Some of the market data contained in this prospectus is based on independent industry publications, including those generated by IBISWorld, Gartner, Inc., SNL Financial, The Kaiser Family Foundation and Health Research & Educational Trust, and other publicly available information. These data involve a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We believe and act as if the third party data contained herein, and the underlying economic assumptions relied upon therein, are generally reliable. In addition, projections, assumptions, and estimates of our future performance and the future performance of the industry in which we operate are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us.

 

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The Gartner Report described herein, “ Forecast: Enterprise IT Spending by Vertical Industry Market, Worldwide, 1Q13 Update ,” April 18, 2013, or the Gartner Report, represents data, research opinion or viewpoints published as part of a syndicated subscription service, by Gartner, Inc., or Gartner, and is not a representation of fact. The Gartner Report speaks as of its original publication date (and not as of the date of this prospectus) and the opinions expressed in the Gartner Report are subject to change without notice.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of the shares of common stock offered by us will be approximately $         million based on an assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters’ option to purchase additional shares in this offering is exercised in full, we estimate that our net proceeds will be approximately $         million. A $1.00 increase or decrease in the assumed initial public offering price of $         per share would increase or decrease the net proceeds to us from this offering by $         million, assuming the number of shares offered by us, as indicated on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any proceeds from the sale of common stock by the selling stockholders.

The principal purposes of this offering are to increase our financial flexibility, increase our visibility in the marketplace, and create a public market for our common stock. As of the date of this prospectus, we cannot specify with certainty all of the uses for the net proceeds from this offering. However, we expect to use the net proceeds from this offering for working capital purposes and other general corporate purposes, including executing our growth strategy, developing new products and services, and funding additional capital expenditures, potential acquisitions, and investments.

Management’s plans for the proceeds of this offering are subject to change due to unforeseen events and opportunities, and the amounts and timing of our actual expenditures depend on several factors including, but not limited to, the cash used in or generated by our operations. Accordingly, our management team will have broad discretion in using the net proceeds from this offering. Therefore, we are unable to estimate the amount of net proceeds from this offering that will be used for any of the potential purposes described above. Pending the use of proceeds from this offering, we intend to invest the net proceeds in short-term, investment-grade, interest-bearing securities.

DIVIDEND POLICY

We have never declared or paid any cash dividend on our common stock. We currently intend to retain all of our future earnings, if any, generated by our operations for the development and growth of our business for the foreseeable future. The decision to pay dividends is at the discretion of our board of directors and depends upon our financial condition, results of operations, capital requirements, and other factors that our board of directors deems relevant.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and our capitalization as of June 30, 2013:

 

  Ÿ  

on an actual basis;

 

  Ÿ  

on a pro forma basis to give effect to the transactions described under “Certain Relationships and Related-Party Transactions—Corporate Restructuring” that will occur prior to the closing of this offering, and the conversion of the outstanding shares of our redeemable convertible preferred stock into an aggregate of 16,496,860 shares of our common stock, but not the stock split; and

 

  Ÿ  

on a pro forma as adjusted basis to give effect to our sale of             shares of common stock in this offering at an assumed initial public offering price of $             per share, which is the midpoint of the range set forth on the cover page of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

The following information is illustrative only of our cash and cash equivalents and capitalization after the completion of this offering and will change based on the actual public offering price and other terms of this offering determined at pricing. You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes appearing elsewhere in this prospectus.

 

     As of June 30, 2013  
     Actual     Pro forma     Pro forma
as adjusted
 
     (in thousands, except share
and per share data)
 

Cash and cash equivalents

   $ 13,673      $ 13,673      $                
  

 

 

   

 

 

   

 

 

 

Redeemable convertible preferred stock:

      

Convertible Series A preferred stock, no par value, 14,055,851 shares authorized, issued and outstanding, actual; $0.001 par value, no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

     105,505            

Convertible Series B preferred stock, no par value, 2,441,009 shares authorized, issued and outstanding, actual; $0.001 par value, no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

     29,973            

Stockholders’ deficit:

      

Preferred stock, par value $0.001, no shares authorized, issued and outstanding, actual; 5,000,000 shares authorized, no shares issued or outstanding, pro forma and pro forma as adjusted

                

Common stock, no par value, 100,000,000 shares authorized, 20,147,905 and 4,815,189 shares issued and outstanding, respectively, actual; $0.001 par value, 50,000,000 shares authorized, 36,644,765 and 21,312,049 shares issued and outstanding, respectively, pro forma; $0.001 par value,             shares authorized,             shares issued and outstanding, pro forma as adjusted

     7,190        21     

Additional paid-in capital

            142,647     

Accumulated deficit

     (186,536     (186,536  
  

 

 

   

 

 

   

 

 

 

Total stockholders’ deficit

     (179,346     (43,868  
  

 

 

   

 

 

   

 

 

 

Total capitalization

   $ (43,868   $ (43,868   $               
  

 

 

   

 

 

   

 

 

 

 

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Each $1.00 increase or decrease in the assumed initial public offering price of $         per share, which is the midpoint of the range set forth on the cover page of this prospectus, would increase or decrease pro forma as adjusted cash and cash equivalents, additional paid-in capital, total stockholders’ deficit and total capitalization by approximately $         million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses.

The number of shares of common stock outstanding in the table above does not include:

 

  Ÿ  

3,243,356 shares of common stock issuable upon exercise of stock options outstanding at a weighted-average exercise price of $6.50 per share, of which 2,460,377 shares with a weighted-average exercise price of $5.52 per share were vested and exercisable;

 

  Ÿ  

500,000 shares of common stock issuable upon exercise of a warrant at an exercise price of $5.48 per share; and

 

  Ÿ  

175,055 shares of common stock available for future issuance under our stock plans.

 

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DILUTION

If you invest in our common stock in this offering, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering. We calculate net tangible book value per share by dividing the net tangible book value (tangible assets less total liabilities) by the number of outstanding shares of our common stock.

Our pro forma net tangible book value as of June 30, 2013 was $(46.9) million, or $(2.20) per share of common stock, based on 21,312,049 shares of our common stock outstanding, after giving effect to the conversion of 16,496,860 shares of redeemable convertible preferred stock into an equivalent number of shares of common stock upon the closing of this offering.

After giving effect to our sale of                 shares of our common stock by us in this offering at an assumed initial public offering price of $         per share (which represents the midpoint of the estimated price range shown on the cover page of this prospectus), less the estimated underwriting discounts and commissions and the estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of June 30, 2013, would be $        , or $         per share. This represents an immediate increase in the pro forma as adjusted net tangible book value of $         per share to existing stockholders and an immediate dilution of $         per share to investors purchasing shares in this offering. The following table illustrates this per share dilution:

 

Assumed initial public offering price

   $                

Pro forma net tangible book value per share as of June 30, 2013

   $ (2.20

Increase per share attributable to this offering

   $     

Pro forma as adjusted net tangible book value per share after this offering

   $     

Net tangible book value dilution per share to investors in this offering

   $     

If the underwriters exercise their option in full, the pro forma as adjusted net tangible book value per share after giving effect to this offering would be approximately $         per share, and the dilution in net tangible book value per share to investors in this offering would be approximately $         per share.

The following table shows, as of June 30, 2013, on the pro forma basis described above, the difference between the number of shares of common stock purchased from us, the total consideration paid to us and the weighted average price paid per share by existing stockholders and by investors purchasing shares of our common stock in this offering:

 

     Shares Purchased     Total Consideration     Average Price
per Share
 
     Number    Percentage     Amount      Percentage    

Existing Stockholders

               $                                     $                   

New Investors

                          
  

 

    

 

 

      

 

 

 

Total

                   
  

 

    

 

 

      

 

 

 

Assuming the underwriters’ option is exercised in full, sales by us in this offering will reduce the percentage of shares held by existing stockholders to     % and will increase the number of shares held by new investors to             , or     %.

Each $1.00 increase (decrease) in the assumed public offering price per share of common stock would increase (decrease) the pro forma as adjusted net tangible book value by $         per share (assuming no exercise of the underwriters’ option to purchase additional shares) and the net tangible book value dilution to investors in this offering by $         per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses.

 

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Assuming no exercise of the underwriters’ option, sales by us and selling stockholders in this offering will reduce the number of shares of common stock held by existing stockholders to             , or     % of the total number of shares of our common stock outstanding after this offering, and will increase the number of shares of our common stock held by new investors to             , or     % of the total number of shares of our common stock outstanding after this offering. Assuming the underwriters’ overallotment option is exercised in full, sales by us and selling stockholders in this offering will reduce the percentage of shares held by existing stockholders to     % and will increase the number of shares held by new investors to             , or     %.

The above discussion is based on 21,312,049 shares of our common stock outstanding as of June 30, 2013 after giving effect to the conversion of 16,496,860 shares of redeemable convertible preferred stock into an equivalent number of shares of our common stock upon the closing of this offering, and excludes:

 

  Ÿ  

3,243,256 shares of common stock issuable upon exercise of stock options outstanding at a weighted-average exercise price of $6.50 per share, of which 2,460,377 shares with a weighted-average exercise price of $5.52 per share were vested and exercisable;

 

  Ÿ  

500,000 shares of common stock issuable upon exercise of a warrant at an exercise price of $5.48 per share; and

 

  Ÿ  

175,055 shares of common stock available for future issuance under our stock plans.

 

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CONSOLIDATED SELECTED FINANCIAL DATA

The following selected consolidated financial data for the years ended December 31, 2010, 2011, and 2012 and the selected consolidated balance sheet data as of December 31, 2010, 2011, and 2012 are derived from our audited consolidated financial statements, which have been audited by our independent registered public accounting firm, Ernst & Young LLP. The selected consolidated statement of operations data for the six months ended June 30, 2012 and 2013 and the selected consolidated balance sheet data as of June 30, 2013 are derived from unaudited consolidated financial statements. Our historical results are not necessarily indicative of the results to be expected in the future, and our operating results for the six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2013. The selected consolidated financial data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our consolidated financial statements, related notes, and other financial information included elsewhere in this prospectus.

Consolidated Statement of Operations Data

 

    Year Ended December 31,     Six Months Ended
June 30,
 
              2010                          2011                          2012                          2012                          2013             
    (in thousands, except share and per share data)  

Revenue(1)

  $       67,122      $ 68,783      $ 81,739      $ 38,698      $ 48,179   

Cost of revenue(2)

    39,817        43,034        45,178        22,231        27,170   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    27,305        25,749        36,561        16,467        21,009   

Operating expenses:

         

Sales and marketing(2)

    14,462        22,914        28,268        15,064        19,905   

Research and development(2)

    8,948        9,397        15,035        7,710        10,505   

General and administrative(2)

    6,144        5,921        7,577        3,753        5,608   

Impairment of goodwill

           1,670                        

Change in fair value of contingent consideration

           503        121        170        (43
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    29,554        40,405        51,001        26,697        35,975   

Loss from operations

    (2,249     (14,656     (14,440     (10,230     (14,966
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense, net

    (96     (241     (214     (99     (173
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (2,345     (14,897     (14,654     (10,329     (15,139

Income tax expense

    10        35        84        39        40   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

  $ (2,355   $ (14,932   $ (14,738   $ (10,368   $ (15,179
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share—basic and diluted

  $ (0.37   $ (3.06   $ (3.06   $ (2.15   $ (3.16
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net loss per share—basic and diluted(3)

      $ (0.69     $ (0.71
     

 

 

     

 

 

 

Weighted-average common shares outstanding—basic and diluted

    6,405,944        4,875,157        4,812,632        4,818,117        4,803,812   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding—pro forma

        21,309,492          21,300,672   
     

 

 

     

 

 

 

Other Financial Data:

         

Adjusted gross profit(4)

  $ 33,498      $ 32,163      $ 44,164      $ 20,794      $ 24,420   

Adjusted EBITDA(5)

  $ 5,245      $ (5,209   $ (5,445   $ (5,162   $ (10,692

 

(1)

In the first quarter of 2011, we increased the estimated expected life of our customer relationships for both employer and carrier customers. This change extends the term over which

 

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we will recognize our deferred revenue. In the absence of this change, each of revenue, gross profit, and net loss would have improved by $5.8 million in 2011 and $2.8 million in 2012.

 

(2) Cost of revenue and operating expenses include stock-based compensation expense as follows:

 

     Year Ended December 31,      Six Months Ended
June 30,
 
         2010              2011              2012              2012              2013      
     (in thousands)  

Cost of revenue

   $     352       $     252       $     195       $     84       $     131   

Sales and marketing

     77         102         68         30         64   

Research and development

     87         121         130         57         133   

General and administrative

     519         246         319         140         209   

 

(3) Pro forma basic and diluted net loss per share have been calculated assuming the conversion of all outstanding shares of redeemable convertible preferred stock into an aggregate of 16,496,860 shares of common stock as of the beginning of the applicable period.

 

(4) We define adjusted gross profit as gross profit before depreciation and amortization expense, as well as stock-based compensation expense. Please see “Adjusted Gross Profit and Adjusted EBITDA” below for more information and for a reconciliation of adjusted gross profit to gross profit, the most directly comparable financial measure calculated and presented in accordance with GAAP.

 

(5) We define adjusted EBITDA as net loss before net interest and other expense, taxes, and depreciation and amortization expense, adjusted to eliminate stock-based compensation expense and expense related to the impairment of goodwill and intangible assets. See “Adjusted Gross Profit and Adjusted EBITDA” below for more information and for a reconciliation of adjusted EBITDA to net loss, the most directly comparable financial measure calculated and presented in accordance with GAAP.

Our Segments

 

     Years Ended December 31,     Six Months Ended
June 30,
 
     2010     2011     2012     2012     2013  
     (in thousands)  

Revenue:

          

Employer

   $ 9,356      $ 15,947      $ 23,760      $ 10,461      $ 17,593   

Carrier

     57,766        52,836        57,979        28,237        30,586   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

   $ 67,122      $ 68,783      $ 81,739      $ 38,698      $ 48,179   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit:

          

Employer

   $ 2,926      $ 5,811      $ 9,499      $ 3,905      $ 6,947   

Carrier

     24,379        19,938        27,062        12,562        14,062   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total gross profit

   $ 27,305      $ 25,749      $ 36,561      $ 16,467      $ 21,009   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations:

          

Employer

   $ (7,036   $ (20,226   $ (19,778   $ (11,792   $ (12,443

Carrier

     4,787        5,570        5,338        1,562        (2,523
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loss from operations

   $ (2,249   $ (14,656   $ (14,440   $ (10,230   $ (14,966
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Consolidated Balance Sheet Data

 

     As of December 31,     As of June 30,  
     2010     2011     2012     2013  
     (in thousands)  

Cash and cash equivalents

   $ 18,166      $ 15,856      $ 19,703      $ 13,673   

Accounts receivable, net

     7,163        9,060        13,372        18,793   

Total assets

     46,507        46,271        51,921        54,837   

Deferred revenue, total

     32,952        42,773        57,520        66,175   

Total liabilities

     47,502        62,012        81,691        98,705   

Total redeemable convertible preferred stock

     135,478        135,478        135,478        135,478   

Common stock

     4,078        4,923        6,109        7,190   

Total stockholders’ deficit

     (136,475     (151,219     (165,248     (179,346

Adjusted Gross Profit and Adjusted EBITDA

Within this prospectus we use adjusted gross profit and adjusted EBITDA to provide investors with additional information regarding our financial results. Adjusted gross profit and adjusted EBITDA are non-GAAP financial measures. We have provided below reconciliations of these measures to the most directly comparable GAAP financial measures, which for adjusted gross profit is gross profit, and for adjusted EBITDA is net loss.

We have included adjusted gross profit and adjusted EBITDA in this prospectus because they are key measures 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 gross profit and adjusted EBITDA can provide a useful measure for period-to-period comparisons of our core business. Accordingly, we believe that adjusted gross profit and adjusted EBITDA provide useful information to investors and others in understanding and evaluating our operating results.

Our use of adjusted gross profit and adjusted EBITDA as analytical tools has limitations, and you should not consider them in isolation or as substitutes for analysis of our financial results as reported under GAAP. Some of these limitations are:

 

  Ÿ  

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized might have to be replaced in the future, and adjusted gross profit and adjusted EBITDA do not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;

 

  Ÿ  

adjusted gross profit and adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs;

 

  Ÿ  

adjusted gross profit and adjusted EBITDA do not reflect the potentially dilutive impact of stock-based compensation;

 

  Ÿ  

adjusted gross profit and adjusted EBITDA do not reflect interest or tax payments that could reduce the cash available to us; and

 

  Ÿ  

other companies, including companies in our industry, might calculate adjusted gross profit and adjusted EBITDA or similarly titled measures differently, which reduces their usefulness as comparative measures.

 

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Because of these and other limitations, you should consider adjusted gross profit and adjusted EBITDA alongside other GAAP-based financial performance measures, including various cash flow metrics, gross profit, net income (loss) and our other GAAP financial results. The following table presents a reconciliation of adjusted gross profit to gross profit and adjusted EBITDA to net loss for each of the periods indicated:

 

     Years Ended December 31,     Six Months Ended
June 30,
 
     2010     2011     2012     2012     2013  
     (in thousands)  

Reconciliation from Gross Profit to Adjusted Gross Profit:

          

Gross profit

   $   27,305      $ 25,749      $ 36,561      $ 16,467      $   21,009   

Depreciation and amortization

     5,841        6,162        7,408        4,243        3,280   

Stock-based compensation expense

     352        252        195        84        131   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted gross profit

   $ 33,498      $ 32,163      $ 44,164      $ 20,794      $ 24,420   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reconciliation from Net Loss to Adjusted EBITDA:

          

Net loss

   $ (2,355   $ (14,932   $ (14,738   $ (10,368   $ (15,179

Depreciation and amortization

     6,343        7,040        8,294        4,754        3,752   

Interest expense

     212        203        203        102        158   

Income tax expense

     10        35        84        39        40   

Stock-based compensation expense

     1,035        721        712        311        537   

Impairment of goodwill and intangible assets

            1,724                        
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net adjustments

   $ 7,600      $ 9,723      $ 9,293      $ 5,206      $ 4,487   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 5,245      $ (5,209   $ (5,445   $ (5,162   $ (10,692
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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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 prospectus. Some of the information contained in this discussion and analysis or set forth elsewhere in this prospectus, 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 prospectus beginning on page 12 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

We are a leading provider of cloud-based benefits software solutions for consumers, employers, insurance carriers, and brokers. The Benefitfocus platform provides an integrated suite of solutions that enables our employer and insurance carrier customers to more efficiently shop, enroll, manage, and exchange benefits information. Our web-based platform has a user-friendly interface designed to enable the insured consumers to access all of their benefits in one place. Our comprehensive solutions support core benefits plans, including healthcare, dental, life, and disability insurance, and voluntary benefits plans, such as critical illness, supplemental income, and wellness programs. 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 has grown.

We serve two separate but related market segments. Our fastest growing market segment, the employer market, consists of employers offering benefits to their employees. Within this segment, we mainly target large employers with more than 1,000 employees, of which we believe there are approximately 18,000 in the United States. In our other market segment, we sell our solutions to insurance carriers, enabling us to expand our overall footprint in the benefits marketplace by aggregating many key constituents, including consumers, employers, and brokers. Our business model capitalizes on the close relationship between carriers and their members, and the carriers’ ability to serve as lead generators for potential employer customers. Carriers pay for services at a rate reflective of the aggregated nature of their customer base on a per application basis. Carriers can then deploy their applications to employer groups and members. As employers become direct customers through our employer segment, we provide them our platform offering that bundles many software applications into a comprehensive benefits solution through HR InTouch. We believe our presence in both the employer and insurance carrier markets gives us a strong position at the center of the benefits ecosystem.

We sell our software solutions and related services primarily through our direct sales force. We derive most of our revenue from software services fees, which primarily consist of monthly subscription fees paid to us for access to and usage of our cloud-based benefits software solutions, and related professional services. Software services fees paid to us from our employer customers are generally based on the number of employees covered by the relevant benefits plans at contracted rates for a specified period of time, which is usually one year. Software services fees paid to us from our carrier customers are based on the number of members contracted to use our solutions at contracted rates for a specified period of time, which usually ranges from three to five years. Our carrier contracts are generally only cancellable by the carrier in an instance of our uncured breach, although some of our carrier customers are able to terminate their respective contracts without cause or for convenience. Software services revenue accounted for approximately 89%, 95%, and 93% of our total revenue during the years ended December 31, 2010, 2011, and 2012, respectively, and for approximately 93% of our total revenue during the six months ended June 30, 2012 and 2013.

 

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Another component of our revenue is professional services. We derive the majority of our professional services revenue from the implementation of our customers onto our platform, which typically includes discovery, configuration and deployment, integration, testing, and training. In general, it takes from four to five months to implement a new employer customer’s benefits systems and eight to 10 months to implement a new carrier customer’s benefits systems. 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 approximately 11%, 5%, and 7% of our total revenue during the years ended December 31, 2010, 2011, and 2012, respectively, and for approximately 7% of our total revenue during the six months ended June 30, 2012 and 2013.

Increasing our base of large employer customers is an important source of revenue growth for us. We actively pursue new employer customers in the U.S. market, and we have increased the number of large employer customers utilizing our solutions from 118 as of December 31, 2009 to 348 as of June 30, 2013, a 36.2% compound annual growth rate, or CAGR. We believe that our continued innovation and new solutions, such as online benefits marketplaces, also known as private exchanges, enhanced mobile offerings, and more robust data analytics capabilities will help us attract additional large employer customers and increase our revenue from existing customers.

We believe that there is a substantial market for our services, and we have been investing in growth over the past two 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 three years, and expect our operating losses to continue at least through the end of 2013. Due to the nature of our customer relationships, which have been very stable with relatively few customer losses over the past years, and the subscription nature of our financial model, we believe that our current investment in growth should lead to substantially increased revenue, which will 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, as well as segment revenue and components of segment loss from operations, 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.

Number of Large Employer and Carrier Customers

We believe the number of large employer and carrier customers is a key indicator of our market penetration, growth, and future revenue. We have aggressively invested in and intend to continue to invest in our direct sales force to grow our customer base. We generally define a customer as an entity with an active software services contract as of the measurement date. The following table sets forth the number of large employer and carrier customers for the periods indicated:

 

     Year Ended December 31,      Six Months Ended
June 30,
 
         2009              2010              2011              2012              2012              2013      

Number of customers:

                 

Large employer

     118         141         193         286         239         348   

Carrier

     28         29         30         34         33         37   

 

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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.

For the years ended December 31, 2011 and 2012, and the six months ended June 30, 2012 and 2013, our software services revenue retention rate exceeded 95%.

Adjusted Gross Profit and Adjusted EBITDA

Adjusted gross profit represents our gross profit before depreciation and amortization, as well as stock-based compensation expense. 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. Adjusted gross profit and adjusted EBITDA are not measures calculated in accordance with United States generally accepted accounting principles, or GAAP. Please refer to “Selected Consolidated Financial Data—Adjusted Gross Profit and Adjusted EBITDA” in this prospectus for a discussion of the limitations of adjusted gross profit and adjusted EBITDA and reconciliations of adjusted gross profit to gross profit and adjusted EBITDA to net loss, the most comparable GAAP measurements, respectively, for the years ended December 31, 2010, 2011, and 2012, and the six months ended June 30, 2012 and 2013.

Components of Operating Results

Revenue

We derive the majority of our revenue from software services fees, which consist primarily of 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 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 between software services and professional services for the periods indicated (in thousands):

 

     Year Ended December 31,      Six Months Ended
June 30,
 
     2010      2011      2012      2012      2013  

Revenue:

              

Software services

   $ 59,425       $ 65,210       $ 75,931       $ 36,042       $ 44,925   

Professional services

     7,697         3,573         5,808         2,656         3,254   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 67,122       $ 68,783       $ 81,739       $ 38,698       $ 48,179   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We generally recognize software services fees monthly based on the number of employees covered by the relevant benefits plans at contracted rates for a specified period of time, provided that an enforceable contract has been signed by both parties, access to our software has been granted to

 

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the customer and is available for their use, the fee for the software services is fixed or determinable, and collection is reasonably assured. We defer recognition of our professional services fees paid by customers in connection with implementation of our software services, or implementation fees, and recognize them, beginning once the software services have commenced, ratably over the longer of the contract term or the estimated expected life of the customer relationship.

In the first quarter of 2011, we increased the estimated expected life of our customer relationships for both employer and carrier customers. This change in estimate was a result of growing demand for our software services, reduced uncertainties in the regulatory environment, and increased confidence in customer retention. This change extends the term over which we recognize our deferred revenue. In the absence of this change, each of revenue, gross profit, and net loss would have improved by $5.8 million in 2011 and $2.8 million in 2012. Most of our deferred revenue relates to professional services performed for our carrier customers, which require a more extensive and lengthy implementation. Further, prior to 2012, we generally did not charge implementation fees to our large employer customers. We will continue to periodically evaluate the term over which revenue is recognized for most professional services as we gain more experience with customer contract renewals.

We generally invoice our employer and carrier customers for software services in advance, in monthly installments. We invoice our employer customers for implementation fees at the inception of the arrangement. We generally invoice our carrier customers for implementation fees at various contractually defined times throughout the implementation process. Implementation fees that have been invoiced are initially recorded as deferred revenue until recognized as described above.

Overhead Allocation

Expenses associated with our facilities, IT costs, 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 associates providing 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, amortization expenses associated with capitalized software development costs, allocated overhead, and other direct costs.

Our cost of revenue is expensed as we incur the costs. However, the related revenue from fees we receive for our implementation services performed before a customer is operating on our platform is deferred until the commencement of the monthly subscription and recognized as revenue ratably over the longer of the related contract term or the estimated expected life of the customer relationship. Therefore, the cost incurred in providing these services is expensed in periods prior to the recognition of the corresponding revenue. Our cost associated with providing implementation services has been significantly higher as a percentage of revenue than our cost associated with providing our monthly subscription services due to the labor associated with providing implementation services.

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.

 

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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. As a result, we expect our operating expenses to increase in both aggregate dollars and as a percentage of revenue in the near term, but to decrease over the longer term 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. We record expense for commissions at the time of contract signing. Additional expenses include advertising, lead generation, promotional event programs, corporate communications, travel, and allocated overhead. For instance, our most significant promotional event is One Place, which we hold annually in the second quarter. We expect our sales and marketing expense to increase in both absolute dollars and as a percentage of revenue in the foreseeable future as we further increase the number of our sales and marketing professionals and 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. We expect our research and development expense to increase in absolute dollars and as a percentage of revenue for the near term, but decrease as a percentage of revenue over the longer term as we achieve economies of scale.

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 our preparation to become and operate as a public company. After the completion of this offering, these expenses will also include costs associated with compliance with the Sarbanes-Oxley Act and other regulations governing public companies, increased costs of directors’ and officers’ liability insurance, increased professional services expenses, and costs associated with an enhanced investor relations function.

Impairment of goodwill.     On August 3, 2010, we acquired 100% of the net assets of Beninform Holdings, Inc., or Beninform, and recorded $3.3 million of goodwill in connection with the acquisition. During the year ended December 31, 2011, we recorded an impairment of goodwill of $1.7 million due to lower than expected sales forecast at the October 31, 2011 impairment testing date.

Other Income and Expense

Other income and expense consists primarily of interest income and expense, accretion of contingent consideration, and gain (loss) on disposal of fixed assets. Interest income represents interest received on our cash and cash equivalents. Interest expense consists primarily of the interest incurred on outstanding borrowings under our existing notes and credit facilities.

 

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Income Tax Expense

Income tax expense consists of U.S. federal and state income taxes. We incurred minimal income tax expense for the years ended December 31, 2010, 2011, and 2012, and the six months ended June 30, 2012 and 2013. Net operating loss carryforwards for federal income tax purposes were $25.6 million at December 31, 2012. State net operating loss carryforwards were approximately $23.6 million at December 31, 2012. Federal net operating loss carryforwards will expire at various dates beginning in 2016 through 2032, if not utilized. State net operating losses will expire at various dates beginning in 2019 through 2032, 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.

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,     Six Months
Ended June 30,
 
     2010     2011     2012     2012     2013  

Revenue

   $   67,122      $ 68,783      $ 81,739      $ 38,698      $   48,179   

Cost of revenue(1)

     39,817        43,034        45,178        22,231        27,170   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     27,305        25,749        36,561        16,467        21,009   

Operating expenses:

          

Sales and marketing(1)

     14,462        22,914        28,268        15,064        19,905   

Research and development(1)

     8,948        9,397        15,035        7,710        10,505   

General and administrative(1)

     6,144        5,921        7,577        3,753        5,608   

Impairment of goodwill

            1,670                        

Change in fair value of contingent consideration

            503        121        170        (43
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     29,554        40,405        51,001        26,697        35,975   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (2,249     (14,656     (14,440     (10,230     (14,966

Other income (expense):

          

Interest income

     364        151        53        32        23   

Interest expense

     (212     (203     (203     (102     (158

Other expense

     (248     (189     (64     (29     (38
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense, net

     (96     (241     (214     (99     (173
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (2,345     (14,897     (14,654     (10,329     (15,139

Income tax expense

     10        35        84        39        40   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (2,355   $ (14,932   $ (14,738   $ (10,368   $ (15,179
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Cost of revenue and operating expenses include stock-based compensation expense as follows (in thousands):

 

     Year Ended December 31,      Six Months Ended
June 30,
 
         2010              2011              2012          2012      2013  

Cost of revenue

   $ 352       $ 252       $ 195       $ 84       $ 131   

Sales and marketing

     77         102         68         30         64   

Research and development

     87         121         130         57         133   

General and administrative

     519         246         319         140         209   

 

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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,     Six Months
Ended June 30,
 
         2010             2011             2012             2012             2013      

Revenue

     100.0     100.0     100.0     100.0     100.0

Cost of revenue

     59.3        62.6        55.3        57.4        56.4   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     40.7        37.4        44.7        42.6        43.6   

Operating expenses:

          

Sales and marketing

     21.5        33.3        34.6        38.9        41.3   

Research and development

     13.3        13.7        18.4        19.9        21.8   

General and administrative

     9.2        8.6        9.3        9.7        11.6   

Impairment of goodwill

            2.4                        

Change in fair value of contingent consideration

            0.7        0.1        0.4        (0.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     44.0        58.7        62.4        69.0        74.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (3.4     (21.3     (17.7     (26.4     (31.1

Other income (expense):

          

Interest income

     0.5        0.2        0.1        0.1        0.0   

Interest expense

     (0.3     (0.3     (0.2     (0.3     (0.3

Other expense

     (0.4     (0.3     (0.1     (0.1     (0.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense, net

     (0.1     (0.4     (0.3     (0.3     (0.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (3.5     (21.7     (17.9     (26.7     (31.4

Income tax expense

     0.0        0.1        0.1        0.1        0.1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (3.5 )%      (21.7 )%      (18.0 )%      (26.8 )%      (31.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Our Segments

The following table sets forth segment results for revenue, gross profit, and loss from operations for the periods indicated (in thousands):

 

     Year Ended December 31,     Six Months
Ended June 30,
 
     2010     2011     2012     2012     2013  

Revenue:

          

Employer

   $ 9,356      $ 15,947      $ 23,760      $ 10,461      $ 17,593   

Carrier

     57,766        52,836        57,979        28,237        30,586   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

   $ 67,122      $ 68,783      $ 81,739      $ 38,698      $ 48,179   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit:

          

Employer

   $ 2,926      $ 5,811      $ 9,499      $ 3,905      $ 6,947   

Carrier

     24,379        19,938        27,062        12,562        14,062   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total gross profit

   $ 27,305      $ 25,749      $ 36,561      $ 16,467      $ 21,009   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations:

          

Employer

   $ (7,036   $ (20,226   $ (19,778   $ (11,792   $ (12,443

Carrier

     4,787        5,570        5,338        1,562        (2,523
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loss from operations

   $ (2,249   $ (14,656   $ (14,440   $ (10,230   $ (14,966
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Comparison of Six Months Ended June 30, 2012 and 2013

Revenue

 

     Six Months Ended June 30,               
     2012     2013     Period-to-Period  Change  
     Amount      Percentage of
Revenue
    Amount      Percentage of
Revenue
   
               Amount      Percentage  
     (dollars in thousands)  

Software services

   $ 36,042         93.1   $ 44,925         93.2   $ 8,883         24.6

Professional services

     2,656         6.9        3,254         6.8        598         22.5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Total revenue

   $ 38,698         100.0   $ 48,179         100.0   $ 9,481         24.5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Revenue increased by $9.5 million, or 24.5%, from $38.7 million for the six months ended June 30, 2012 to $48.2 million for the six months ended June 30, 2013. Our software services revenue increased $8.9 million, or 24.6%, for the six months ended June 30, 2013 as compared to the six months ended June 30, 2012, and our professional services revenue increased $0.6 million, or 22.5%, for the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. Growth in both software services and professional services revenues was primarily attributable to the addition of new customers, as the number of large employer and carrier customers increased from 272 as of June 30, 2012 to 385 as of June 30, 2013.

Segment Revenue

 

     Six Months Ended June 30,               
     2012     2013     Period-to-Period  Change  
     Amount      Percentage of
Revenue
    Amount      Percentage of
Revenue
   
               Amount      Percentage  
     (dollars in thousands)  

Employer

   $ 10,461         27.0   $ 17,593         36.5   $ 7,132         68.2

Carrier

     28,237         73.0        30,586         63.5        2,349         8.3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Total revenue

   $ 38,698         100.0   $ 48,179         100.0   $ 9,481         24.5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Our employer revenue increased by $7.1 million, or 68.2%, from $10.5 million for the six months ended June 30, 2012 to $17.6 million for the six months ended June 30, 2013. This growth was primarily attributable to a $7.0 million increase in our employer software services revenue driven primarily by an increase in the number of large employer customers using our platform as of June 30, 2013 as compared to June 30, 2012. Our carrier revenue increased $2.3 million, or 8.3%, during the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. This growth was primarily attributable to an increase of $1.9 million in our carrier software services revenue, driven primarily by an increase in the number of carrier customers using our platform as well as an increase in the number of products being utilized by our carrier customers during the six months ended June 30, 2013 as compared to the six months ended June 30, 2012.

Cost of Revenue

 

     Six Months Ended June 30,               
     2012     2013     Period-to-Period Change  
     Amount      Percentage of
Revenue
    Amount      Percentage of
Revenue
   
               Amount       Percentage   
     (dollars in thousands)  

Cost of revenue

   $ 22,231         57.4   $ 27,170         56.4   $ 4,939         22.2

 

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Cost of revenue increased by $4.9 million, or 22.2%, from $22.2 million for the six months ended June 30, 2012 to $27.2 million for the six months ended June 30, 2013. As a percentage of revenue, cost of revenue decreased from 57.4% for the six months ended June 30, 2012 to 56.4% for the six months ended June 30, 2013. The increase in cost of revenue in absolute terms was in part attributable to a $3.4 million increase in salaries and personnel-related costs, of which $2.4 million was associated with additional customer service headcount to support a growing number of customers, and $1.0 million was associated with additional engineering headcount to perform customer implementations. In addition, we experienced a $0.7 million increase in professional fees to prepare for an open enrollment period at a large customer and to assist with customer implementations and $0.3 million increase in travel expenses to client sites. Also, we experienced a $0.6 million increase in infrastructure maintenance costs to support our platform, a $0.5 million increase in facilities expenses as a result of adding office space, and a $0.1 million increase in co-location costs due to greater data storage needs. Additional hiring led to a $0.1 million increase in recruiting costs. These increases were partially offset by a decrease of $0.9 million in amortization expense associated with capitalized software development costs primarily due to an impairment charge taken in 2012.

Gross Profit

 

     Six Months Ended June 30,              
     2012     2013     Period-to-Period  Change  
     Amount     Percentage of
Revenue
    Amount     Percentage of
Revenue
   
             Amount     Percentage  
     (dollars in thousands)  

Software services

   $ 21,109        58.6   $ 28,739        64.0   $ 7,630        36.1

Professional services

     (4,642     (174.8     (7,730     (237.6 )%      (3,088     (66.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Gross profit

   $ 16,467        42.6   $ 21,009        43.6   $ 4,542        27.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Software services gross profit increased by $7.6 million, or 36.1%, from $21.1 million for the six months ended June 30, 2012 to $28.7 million for the six months ended June 30, 2013. The increase in software services gross profit was driven by an $8.9 million, or 24.6%, increase in software services revenue, partially offset by a $1.3 million, or 8.4%, increase in software services cost of revenue. Software services cost of revenue included $45,000 and $46,000 of stock-based compensation expense for the six months ended June 30, 2012 and 2013, respectively; and $4.0 million and $3.1 million of depreciation and amortization for the six months ended June 30, 2012 and 2013, respectively. The decrease in depreciation and amortization expense was primarily due to a charge taken in 2012 related to impairment of capitalized software development costs.

Professional services gross loss increased by $3.1 million, or 66.5%, from $4.6 million for the six months ended June 30, 2012 to $7.7 million for the six months ended June 30, 2013. The increase in professional services gross loss was driven by a $3.7 million, or 50.5%, increase in professional services cost of revenue, partially offset by a $0.6 million, or 22.5%, increase in professional services revenue. Professional services cost of revenue included $39,000 and $85,000 of stock-based compensation expense for the six months ended June 30, 2012 and 2013, respectively. In addition, professional services cost of revenue included $0.2 million in depreciation and amortization for the six months ended June 30, 2012 and 2013. As discussed in “Components of Operating Results—Cost of Revenue”, our cost of revenue is expensed as we incur the costs. However, the related revenue from fees we receive for our implementation services performed before a customer is operating on our platform is deferred until the commencement of the monthly subscription and recognized as revenue ratably over the longer of the related contract term or the estimated expected life of the customer relationship, which is currently 10 years. Therefore, the cost incurred in providing these services is expensed in periods prior to the recognition of the corresponding revenue. For this reason, as well as due to the personnel-related costs associated with providing implementation services, our cost

 

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associated with providing implementation services has been significantly higher as a percentage of related revenue than our cost associated with providing our monthly subscription services.

Segment Gross Profit

 

     Six Months Ended June 30,               
     2012     2013     Period-to-Period Change  
     Amount      Percentage of
Revenue
    Amount      Percentage of
Revenue
   
               Amount       Percentage   
     (dollars in thousands)  

Employer

   $ 3,905         37.3   $ 6,947         39.5   $ 3,042         77.9

Carrier

     12,562         44.5        14,062         46.0        1,500         11.9
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Gross profit

   $ 16,467         42.6   $ 21,009         43.6   $ 4,542         27.6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Employer gross profit increased by $3.0 million, or 77.9%, from $3.9 million for the six months ended June 30, 2012 to $6.9 million for the six months ended June 30, 2013. The increase in employer gross profit was driven by a $7.1 million, or 68.2%, increase in employer revenue, partially offset by a $4.1 million, or 62.4%, increase in employer cost of revenue. The increase in cost of revenue in absolute terms is primarily attributable to costs associated with providing implementation services, which increased due to a higher number of new individual employer customer implementations. Our employer gross profit included $1.2 million and $1.1 million of depreciation and amortization for the six months ended June 30, 2012 and 2013, respectively.

Carrier gross profit increased by $1.5 million, or 11.9%, from $12.6 million for the six months ended June 30, 2012 to $14.1 million for the six months ended June 30, 2013. The increase in carrier gross profit was driven by a $2.3 million, or 8.3%, increase in carrier revenue, partially offset by a $0.8 million, or 5.4%, increase in carrier cost of revenue. The increase in cost of revenue in absolute terms is primarily attributable to new individual carrier customer and product implementations, offset by a decrease in depreciation and amortization expense, primarily due to the capitalized software development costs impairment taken in the six months ended June 30, 2012, with no comparable impairment charge in the 2013 period. Our carrier gross profit included $3.1 million and $2.1 million in depreciation and amortization for the six months ended June 30, 2012 and 2013, respectively. In addition, our carrier gross profit included $0.1 million of stock-based compensation expense in both the six months ended June 30, 2012 and the six months ended June 30, 2013.

Sales and Marketing

 

     Six Months Ended June 30,               
     2012     2013     Period-to-Period  Change  
     Amount      Percentage of
Revenue
    Amount      Percentage of
Revenue
   
               Amount      Percentage  
     (dollars in thousands)  

Sales and marketing

   $ 15,064         38.9   $ 19,905         41.3   $ 4,841         32.1

Sales and marketing expense increased by $4.8 million, or 32.1%, from $15.1 million, or 38.9% of revenue, for the six months ended June 30, 2012, to $19.9 million, or 41.3% of revenue, for the six months ended June 30, 2013. The increase in sales and marketing expense was primarily attributable to a $4.4 million increase in commissions and sales bonus expenses due to increased sales during the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. We also hired sales and marketing personnel to continue driving revenue growth. While the newly hired sales and marketing associates did not receive a full six months of salary, the additional hiring resulted in a $0.3 million increase in recruiting costs.

 

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Research and Development

 

     Six Months Ended June 30,               
     2012     2013     Period-to-Period Change  
     Amount      Percentage of
Revenue
    Amount      Percentage of
Revenue
   
               Amount       Percentage   
     (dollars in thousands)  

Research and development

   $ 7,710         19.9   $ 10,505         21.8   $ 2,795         36.3

Research and development expense increased by $2.8 million, or 36.3%, from $7.7 million, or 19.9% of revenue, for the six months ended June 30, 2012, to $10.5 million, or 21.8% of revenue, for the six months ended June 30, 2013. The increase in research and development expense was primarily attributable to a $1.9 million increase in salaries and personnel-related costs and a $0.1 million increase in recruiting costs due to additional research and development headcount. Additionally, we experienced a $0.3 million increase in engineering consulting fees for assistance in product development and a $0.2 million increase in facilities expenses as a result of adding office space.

General and Administrative

     Six Months Ended June 30,               
     2012     2013     Period-to-Period Change  
     Amount      Percentage of
Revenue
    Amount      Percentage of
Revenue
   
               Amount       Percentage   
     (dollars in thousands)  

General and administrative

   $ 3,753         9.7   $ 5,608         11.6   $  1,855         49.4

General and administrative expense increased by $1.9 million, or 49.4%, from $3.8 million, or 9.7% of revenue, for the six months ended June 30, 2012, to $5.6 million, or 11.6% of revenue, for the six months ended June 30, 2013. The increase in general and administrative expense was primarily attributable to a $1.1 million increase in salaries and personnel-related costs associated with an increase in performance-driven management bonuses and an increase in general and administrative personnel to support our growing business. In addition, we experienced a $0.4 million increase in consulting and professional fees and a $0.2 million increase in travel costs incurred in preparation for our IPO.

Segment Income (Loss) From Operations

 

     Six Months Ended June 30,               
     2012     2013     Period-to-Period Change  
     Amount     Percentage of
Revenue
    Amount     Percentage of
Revenue
   
             Amount       Percentage   
     (dollars in thousands)  

Employer

   $ (11,792     (112.7 )%    $ (12,443     (70.7 )%    $ (651      (5.5 )% 

Carrier

     1,562        5.5        (2,523     (8.2     (4,085      (261.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

Loss from operations

   $ (10,230     (26.3 )%    $ (14,966     (31.0 )%    $ (4,736      (46.3 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

Employer loss from operations increased by $0.7 million, or 5.5%, from $11.8 million for the six months ended June 30, 2012 to $12.4 million for the six months ended June 30, 2013. The increase in employer loss from operations was attributable to an increase in employer operating expenses of $3.7

 

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million offset by an increase of $3.0 million in employer gross profit. The increase in operating expenses was primarily attributable to a $2.7 million increase in sales and marketing expense and a $1.0 million increase in general and administrative expense. The increase in sales and marketing expense was attributable to an increase in commissions and sales bonus expenses due to increased sales to new employer customers during the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. We also hired employer sales personnel to continue driving revenue growth. While the newly hired employer sales associates did not receive full six months of salary, the additional hiring resulted in a $0.3 million increase in recruiting costs. The increase in general and administrative expense was primarily attributable to an increase in general and administrative personnel to support our growing business.

Carrier income (loss) from operations decreased by $4.1 million, or 261.5%, from $1.6 million in income for the six months ended June 30, 2012 to a $2.5 million loss for the six months ended June 30, 2013. The decrease in carrier income (loss) from operations was attributable to an increase in carrier operating expenses of $5.6 million offset by an increase of $1.5 million in carrier gross profit. The increase in operating expenses was primarily attributable to increases of $2.6 million, $2.1 million, and $0.8 million in research and development, sales and marketing, and general and administrative expenses, respectively. The increase in research and development expense was primarily driven by a headcount increase attributable to the increased development activity related to the Marketplace product during the six months ended June 30, 2013. The increase in sales and marketing expense was primarily attributable to an increase in commissions and sales bonus expenses due to increased sales during the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. The increase in general and administrative expense was primarily attributable to an increase in general and administrative personnel to support our growing business.

Comparison of Years Ended December 31, 2011 and 2012

Revenue

 

     Year Ended December 31,               
     2011     2012     Period-to-Period Change  
     Amount      Percentage of
Revenue
    Amount      Percentage of
Revenue
   
               Amount      Percentage  
     (dollars in thousands)  

Software services

   $ 65,210         94.8   $ 75,931         92.9   $ 10,721         16.4

Professional services

     3,573         5.2        5,808         7.1        2,235         62.6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Total revenue

   $ 68,783         100.0   $ 81,739         100.0   $ 12,956         18.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

Revenue increased by $13.0 million, or 18.8%, from $68.8 million for the year ended December 31, 2011 to $81.7 million for the year ended December 31, 2012. Our software services revenue increased $10.7 million, or 16.4%, during the year ended December 31, 2012 as compared to the year ended December 31, 2011. This growth was primarily attributable to the addition of new customers as the number of large employer and carrier customers increased from 223 as of December 31, 2011 to 320 as of December 31, 2012. Our professional services revenue increased $2.2 million, or 62.6%, for the year ended December 31, 2012 as compared to the year ended December 31, 2011. The increase in professional services revenue is primarily attributed to an increase in the number of new carrier customers requiring implementation services, as well as completion of those services during the year ended December 31, 2012 as compared to the year ended December 31, 2011.

 

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Segment Revenue

 

     Year Ended December 31,               
     2011     2012     Period-to-Period Change  
     Amount      Percentage of
Revenue
    Amount      Percentage of
Revenue
   
               Amount      Percentage  
     (dollars in thousands)  

Employer

   $ 15,947         23.2   $ 23,760         29.1   $ 7,813         49.0

Carrier

     52,836