Aug 4, 2017
Executives
Michael Bauer – Director-Investor Relations Shawn Jenkins – Chief Executive Officer Ray August – President
Analysts
Nandan Amladi – Deutsche Bank Brian Peterson – Raymond James Frank Sparacino – First Analysis Adam Klauber – William Blair Joe Gallo – Jefferies Nina Deka – Piper Jaffray David Hynes – Canaccord Genuity Ross MacMillan – RBC Capital Markets Steve Wardell – Chardan Capital
Operator
Greetings, and welcome to the Benefitfocus’ Second Quarter 2017 Earnings Call. At this time, all participants are in a listen only mode.
A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Mr. Michael Bauer, Director of Investor Relations.
Thank you. You may begin.
Michael Bauer
Thank you, operator. Good afternoon, and welcome to Benefitfocus’ second quarter 2017 earnings call.
We will be discussing the operating results announced in our press release issued after the close of market today. Joining me today are Shawn Jenkins, our Chief Executive Officer; and Ray August, our President.
Shawn and Ray will offer some prepared remarks and then we will open the call up for Q&A session. As a reminder, today’s discussion will include forward-looking statements such as third quarter and full year 2017 guidance and other predictions, expectations and information that might be considered forward-looking under federal securities laws.
These statements reflect our views as of today only and should not be considered as representing our views of any subsequent date. These statements are subject to a variety of risks and uncertainties, including the fluctuation of our financial results, recruitment and retention of key personnel, general economic risk, the early stage of our market, management of growth and a changing regulatory environment that could cause actual results to differ materially from expectations.
For a further discussion on the material risks and other important factors that could affect our actual results, please refer to our annual report on Form 10-K and our other SEC filings. During the course of today’s call, we will also refer to certain non-GAAP financial measures.
You can find important disclosures about those measures in our press release. With that, let me turn the call over to Shawn.
Shawn Jenkins
Thanks, Mike. Good afternoon, everyone, and thank you all for joining us today.
From a P&L perspective, Benefitfocus delivered strong second quarter results with both revenue and profitability outperforming our targets. During the quarter, consolidated non-GAAP gross margin increased by over 520 basis points and adjusted EBITDA margin improved by nearly 1,100 basis points when compared to the second quarter of 2016.
For the quarter, total revenue increased to $63.3 million and our revenue retention rate once again exceeded 95%. We also ended the quarter with 893 large employer customers and 53 insurance carrier customers.
Overall, these results demonstrated both the positive impact of our multiyear investment and operational excellence, and the inherent scale in our business. When we look at the combination of such strong revenue retention, margin expansion, profitability improvement and approaching free cash flow generation, we see overall significant strengthening in our company.
The growth of Benefitfocus, combined with our larger sales force, led to significant increases in lead generation, sales activity and opportunity pipeline expansion in the first half of the year. One area of continued acceleration is with our employer, Enterprise Account team, which focuses on employers with over 10,000 employees.
During the first half of 2017, our Enterprise team added 15 new customers, up from 6 in the first half of 2016. This impressive performance was driven by both our direct sales team and partner channel, which demonstrates that larger customers are increasingly selecting Benefitfocus as they make their move to the cloud for enterprise benefits management.
Another area of continued strengthening is our customer community, which now numbers over 900 large employers and insurance carriers. The Benefitfocus customer community is increasingly pulling us into their organizations by expanding their use of our new products and services.
Our community’s enthusiasm for our offerings is leading to increasing PEPM and attachment rates, which is great for both our company and customers as it demonstrates the incredible value we are delivering for them. Also during the quarter, our channel partners demonstrated great progress.
Throughout the first half of 2017, we have steadily invested additional channel marketing and sales resources to this important growth engine and remain focused on expanding this strategic part of our business. Our channel opportunity pipeline is growing and we believe it will be a source of growth for Benefitfocus into the future.
While our operational performance during the quarter was impressive, our overall sales performance was mixed. Strength in our enterprise account and back-to-base teams was offset by a continued impact on the ongoing regulatory uncertainty within our strategic account and carrier teams.
We found that the lack of resolution from the ongoing health care debate led to elongated sales cycles and resulted in a higher percentage of our later-stage sales strategic and carrier pipelines to split into both Q3 and 2018 than we’ve historically seen. Importantly, we did not lose these deals.
In fact, our win ratio improved in the quarter. To help you understand why regulatory uncertainty would cause an employer to delay their eventual migration to the cloud, allow me to provide some context.
Using an employer size of 3,500 employees with the average annual health care spend of $5,000 per employee, that employer will spend over $17 million a year on health care benefits alone. This significant recurring business investment requires input from multiple strategic advisers both inside and outside their company.
When regulations affecting this size of spend are expected to change meaningfully, employers begin a lengthened cycle of analysis to evaluate potential outcomes and scenarios. The ultimate impact is that given the value and complexity of the decision, some employers elected to defer meaningful changes to their benefit strategy and benefits platform during the quarter.
In many ways, health insurance carriers are also in a wait-and-see mode as a result of lack of clarity regarding subsidies in their individual market, potential removal of the individual and employer mandates and other potential changes in the regulations governing their industry. As a result of this uncertainty, a number of our carrier opportunities flipped out of the quarter.
Importantly, and similar to our employer pipeline, these opportunities were not lost, simply delayed. In our view, the actual proposed health care policy changes are not the issue creating this dynamic.
It is simply the process of decision makers and employers and carriers adapting to potential new rules. We saw a similar pattern in 2010 as the Affordable Care Act was being created.
Both employers and carriers paused while they interpreted those changes and then began to move aggressively with implementation. That became a nice tailwind for Benefitfocus.
We believe that either new legislation, or now the more likely scenario of moving forward with the existing rules, will lead to accelerated decision-making and a move to the cloud for benefits management. During this period, we have been diligently strengthening our platform, expanding our product portfolio and building a larger sales force.
We believe that we will benefit from each of these investments as our market once again moves ahead with speed. While some of our sales performance in the quarter can be attributed to political environment in Washington, there is room for improvement in our sales execution for the remainder of 2017 and as we enter 2018.
To support our expanded sales organization, we have taken a number of steps, some of which have been underway during the first half of 2017. First, we hired an Executive Vice President of Global Sales to lead our expanded sales organization.
As a growing enterprise software company, we identified the need during the fourth quarter of last year to unify our sales teams and kicked off a national search for a talented leader. As a result of this search, earlier this month, we announced the addition of Robert Dahdah to our executive team.
Robert has excellent experience running and growing successful HCM and SaaS sales teams both domestically and internationally, and will leverage his sales leadership experience to unify our entire sales organization, increase productivity and drive future growth. Robert has an exceptional background.
Most recently, he was the Senior Vice President of Global Sales at Verizon Telematics, one of the world’s largest SaaS, Internet of Things, providers. Prior to that, he served in multiple leadership roles during his 21-year career at ADP, most recently as Senior Vice President of Sales at Global Enterprise Solutions.
In the month that he has been with the company, Robert has already started to implement a structured and data-centric approach across our entire sales organization to improve visibility and accelerate productivity. Second, we are investing in our sales training, development and operations to support our larger sales teams and ensure they are wildly successful.
With an enhanced new sales training and a robust ongoing sales development training program, we are committed to supporting our sales executives as they develop their field. We have also created a leadership and management sales program to deepen our sales management teams’ tool set.
We believe these investments will build tenure and success across all of our sales teams. And third, in response to employers’ increased reliance on brokers and advisers to navigate benefits decisions, we launched the Benefitfocus Preferred Partner Program in late 2016.
This new program helps brokers make benefits technology a key part of their business. Our partnership enables brokers and consultants to win in the market and expand the value they deliver to their customers.
During the quarter, we expanded this program with the addition of several large national and regional insurance brokers. Our investment here will build tighter relationships with this important audience and increase the field support for our on – for our growing sales team.
With this action plan in place, we feel confident that as employers adjust to this new environment, we are well positioned to increase our market penetration and reaccelerate our growth. One of the many factors contributing to our confidence is that the market trends that drive our long-term growth opportunity remains strong.
These trends include the powerful secular shift of core operational activities to the cloud as HR departments demand next-generation benefits administration tools to increase employee engagement, bring benefits to their mobile devices, reduce administrative complexity and leverage data analytics to better control their health care costs. We also continue to make strides within our carrier segment as these large and complex customers consolidate their legacy technology investments on to the Benefitfocus Platform.
In addition to these advancements across our sales organization, during the second quarter, we made significant progress against our stated goal to improve profitability and achieve positive free cash flow by the fourth quarter of this year. In 2Q and the first half of 2017, we posted impressive margin expansion as our technology platform and services captured the benefits of our growing scale.
The investments we have made across our products and company will continue to drive revenue growth and margin expansion over time. We also remain on track to become free cash flow positive by the fourth quarter.
In addition to expanding margins, we continue to allocate ample resources to support our long-term revenue growth objectives through investments in sales, marketing and product development. From a research and development perspective, our Summer Software Release included a number of new capabilities that will set our associates and customers up for a successful open enrollment season and advance Benefitfocus forward as a platform leader in benefits industry.
We also made significant progress in delivering the new products we announced at One Place 2017. Let me provide a few examples.
From a platform perspective, we began an early adopter program for our new advanced reporting product. This is a new offering that can easily combine eligibility, enrollment and claims data in a single enterprise reporting framework.
This new tool allows benefits administrators to quickly design, edit and produce reports that allow them to monitor the performance of their entire benefits investment. The early adopter program is already underway with some of our largest enterprise clients and we anticipate the product will be generally available for all employer customers in our autumn release later this quarter.
In addition to advanced reporting, we introduced the next generation of our data health dashboard as a platform capability. This dashboard provides Benefitfocus associates with the tools they need to review, validate and verify configuration update on behalf of our customers quickly and easily.
The end result is higher data quality and a continued increase in customer satisfaction. From an employer perspective, we also introduced new Smart category, including rehire eligibility.
As the labor market tightened, we have heard from our customers that they are more likely to rehire former employees. With this new Smart category, we have automated this process so that these employees can be quickly onboarded and reenrolled.
And from a carrier perspective, we introduced a brand-new user experience for our Benefitfocus eBilling. For many of our carrier customers, eBilling is a critical component of their customer experience.
In fact, our platform distributed nearly $70 billion of digital invoices in 2016. The all-new user experience simplifies the administrator role and provides a unified customer view.
Overall, when I look at the key forward-looking indicators and the progress we have made during the quarter against our primary initiatives for 2017, it is clear we are gaining strength. Our revenue retention rate continues to exceed 95%; our average PEPM and customer size continue to steadily increase; we continue to innovate and introduce new solutions that expand our addressable market and deliver significant value to our customers; our competitive dynamic is favorable; when a decision to purchase is made, we’re winning an even greater percentage of deals; our platform performance continues to improve; we are benefiting from a greater operational scale resulting in steady margin expansion; we are fielding the largest sales force in our company’s history and as they ramp in tenure, they will benefit from all the investments we’ve made during the past few quarters.
And finally, we will be free cash flow positive in the fourth quarter of this year. This will enable our management team to continue to think long term about our massive market opportunity and make the ongoing investments back into our products and expanded sales teams.
In short, we have the right strategy, leadership team and sales organization to navigate this regulatory environment. I’m excited about the road ahead for Benefitfocus as our investments yield even greater success.
With that, I would also like to thank Annie Lamont who retired from our board in July. Annie has been a valuable member of our team since her fund, Oak Investment Partners, invested in Benefitfocus in 2010.
I would also like to welcome Jonathon Dussault as our new Chief Financial Officer. Jonathon will join the company on August 14, and was previously the Senior Vice President and Senior Finance Officer at WEX Health, a leading provider of cloud-based Health Savings Account technology, and prior to that, the CFO of Evolution1.
Jonathon has fantastic experience within our industry and scaling up software company. As we continue to expand our product and service offering, Jonathon’s experience with Health Savings Account and the healthcare industry will be deeply valuable and will help facilitate our success and unlock value in emerging growth areas of our business.
We’re really excited for both Robert and Jonathon to join our team. Adding these 2 leaders continues a great few years of attracting leadership talent to Benefitfocus.
Finally, I want to extend a special thank you to all of the Benefitfocus associates. The continued growth in our company would not be possible without all of your hard work and dedication.
Thank you for all that you do to create our success in such a strong culture here at Benefitfocus. With that, I’ll hand it over to Ray.
Ray, take it away.
Ray August
Well, thank you, Shawn. I will begin by reviewing the details of our financial performance for Q2 and then I will conclude with our updated guidance for the full year 2017 and our outlook for the third quarter.
Total revenue for the second quarter was $63.3 million, an increase of 9% compared to the second quarter of 2016. This result exceeded our guidance and reflects contributions from the sales of products to both new and existing customers, high revenue retention and the completion of certain professional services projects ahead of schedule.
As discussed in prior quarters, our Q2 results reflect the tough compare from the shift of our ACA reporting product revenue into Q1 2017 from Q2 2016. Recall, in Q2 2016, we recognized as completed $5.1 million of lump sum total ACA reporting revenue, which did not repeat in the current quarter.
To normalize for this shift, we recommend investors view our employer revenue, employer software services revenue, total software services revenue and total revenue on a year-to-date basis. On a year-to-date basis, our total revenue grew 13% compared to the first half of 2016.
Employer revenue for the quarter was $38.8 million, up 7% compared to the year-ago period. For the first half of 2017, employer revenue increased 16% compared to the first half of 2016.
Q2 carrier revenue of $24.5 million was up 13% compared to the same period last year and predominantly reflects increased service revenue recognized in the quarter. During the first half of 2017, our carrier revenue has benefited from accelerated professional services revenue from the second half of the year.
As such, we continue to expect our carrier segment to grow in the low single digits in 2017. For the second quarter, total software services revenue was $53.6 million, representing 85% of total revenue and grew 5% year-over-year.
Employer software services revenue was $35.7 million and also grew 5% year-over-year. For the first half of 2017, software services revenue increased 10% compared to the first half of 2016.
For the first half of 2017, employer software services revenue increased 15% compared to the first half of 2016. Total professional services revenue in Q2 was $9.8 million, representing 15% of total revenue and an increase of 43% over Q2 2016.
The increase in professional services revenue primarily reflects an increase in implementation from customers going live on our platform and the expansion of our broader service offerings. Non-GAAP gross profit totaled $35 million or a 55% non-GAAP gross margin, which compares favorably to the 50% non-GAAP gross margin in Q2 2016.
The over 520 basis point improvement over last year reflects revenue growth and the operational benefit of increasing scale as well as the steady progress in our infrastructure optimization and cost management efforts. These improvements are also evident in both our software and our professional services gross margin.
For the quarter, our non-GAAP software services gross margin of 66% was up 120 basis points year-over-year and our non-GAAP professional services gross margin also continues to make significant improvement. We also continue to drive consistent and impressive year-over-year improvement in our adjusted EBITDA results.
Q2 adjusted EBITDA was $5.4 million or 9% of revenue and marks the fourth consecutive quarter of positive adjusted EBITDA. This was meaningfully above our guidance and up from a negative 2% of revenue in Q2 2016.
Our adjusted EBITDA was positively impacted by our revenue growth in the quarter and increasing our operational scale. Importantly, our management team remains committed to thoughtfully balancing investments to grow our top line and expand margins.
Non-GAAP net loss per share was a loss of $0.05 based on 31.1 million weighted average shares outstanding and exceeded our prior guidance of a loss of $0.16 to $0.13 per share and the year-ago period loss of $0.22 per share. GAAP results for the quarter include gross profit of $34.5 million, representing a margin of 54% and an operating loss of $1.5 million, contributing to a net loss per share of $0.14.
Moving to the balance sheet. We ended Q2 with cash, cash equivalents and marketable securities of $59.4 million.
Total deferred revenue declined $3.8 million sequentially to $65.1 million. As discussed in prior quarters, the decline in deferred revenue reflects the deemphasis of certain lower margin carrier professional service engagements as well as the timing of delivery and new sales in the carrier business.
On the statement of cash flows, cash from operations totaled $1 million for the quarter and compares favorably to the $7.4 million used in the prior quarter and the $0.4 million used in the year-ago period. While our cash flow will still be lumpy on a quarterly basis, we are tremendously proud of once again generating positive operating cash flow, which is indicative of our improved margin profile and improving scale.
I will now turn to our outlook for the third quarter and full year 2017. Starting with our third quarter, we are targeting revenue of $61.5 million to $62.5 million.
From a profitability perspective, we expect adjusted EBITDA of $1 million to $2 million and a non-GAAP net loss of $5 million to $4 million and a non-GAAP net loss per share of $0.16 to $0.13 based on 31.2 million weighted average shares outstanding. For the full year 2017, we now expect total revenue in the range of $255 million to $258 million.
Despite our lowered revenue outlook, we are increasing the midpoint of our profitability targets. We expect adjusted EBITDA of $14 million to $17 million, a non-GAAP net loss of $10.5 million to $7.5 million and a non-GAAP net loss per share of $0.34 to $0.24 based on 31 million weighted average shares outstanding.
Importantly, we continue to expect free cash flow, which we define as cash provided by or used in our operations, less capital expenditures, to be positive by the fourth quarter of 2017. In summary, we remain confident that our thoughtful investments across our company, coupled with a favorable market and competitive backdrop, will not only result in long-term strong top line growth, but also continuation of steady margin expansion for our shareholders.
With that, we are now ready to take your questions. Operator, please begin the question-and-answer session at this time.
Operator
Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Nandan Amladi with Deutsche Bank.
Nandan Amladi
Hi, good afternoon. Thanks for taking my question.
So I think, Shawn, the first thing that stood out in the results is the 40 new employer customers. That’s been the main metric driving your growth.
And I know in the script, you mentioned some delays in decision-making and so on. Where did you see most of these delays?
Were they in the large employer segment, the 10,000-plus? You also touched a little bit on the carriers, or was it the – sort of the core 1,000 employee kind of segment?
Shawn Jenkins
Yes, great. Nandan, when we look at the sales teams, it’s really – I’ll start with the areas of strength that we saw in the second quarter and in the first half.
First of all, actually there’s a lot of strength building and continuing to build in our employer enterprise segment, which is, we characterize, as having 10,000 employees or more. So in the larger end of the market, we’re seeing great buying and great execution of our sales team.
We added 15 of these large enterprises in the first half of the year, up from 6 in the year-ago period. So our deal sizes are getting larger and a lot of strength building there.
And the second area of real strength that we are seeing, continuing to build, is in our customer community. So our customers are really pulling Benefitfocus into their organization.
They’re seeing more ROI. The more products they use from us, they’re excited about the products we’re developing.
And so 2 areas of strength. And then the area that where we’re seeing elongated sales cycles continuing is in our carrier business and in what we refer to as our strategic accounts segment, which are employers that have 1,000 to 10,000 employees.
It’s really interesting, the – this ongoing regulatory uncertainty which, I think, most people in the industry would have thought by summertime would be resolved one way or the other, has continued to be drawn out. And that, combined with really the youthful nature of our sales teams, we’ve added a lot of salespeople in the last 12 months, particularly in strategic accounts, when we put those two dynamics together, we saw elongated sales cycles.
First, I’ll talk a little bit about the carrier segment. These health insurance carriers are particularly waiting for the rules to be finalized as they head into their 2018 pricing of their products and their strategy.
Good news is, the Benefitfocus, our pipeline is really surging. So we have a tremendous carrier pipeline.
It began to build late last year into the first half of this year, but those carriers are in a little bit of a wait-and-see mode as they wait for the final regulations if there’s going to be change or what’s probably more likely now what we’ve seen just in the last week is that we’re going to move forward with the existing regulations, maybe some minor changes to it. So we actually think the second half of the year will be good for our carrier sales team.
We think these carriers will begin to reaccelerate. On the strategic accounts segment in our employer business, we saw elongated sales cycles.
Those are typically faster sales cycles. And as these employers with their brokers and their advisers watch the regulatory uncertainty back and forth, and what the rules will be and who will need to cover going into the new year, we just saw many of them pause or continued their pause through this cycle.
Now importantly, in both of these areas, we’ve not lost these deals. Our sales pipeline is huge with our larger team, the activity has really been terrific, the receptivity to our messaging and the Benefitfocus products.
And so – but we just simply think it’s delayed. So those are going to move into the second half of the year, and in some cases, even in 2018 for the strategic accounts as they begin to prepare for this open enrollment.
And just a quick note, Nandan, on – so what are we doing about it as we see this phenomenon? Clearly, we continue to invest in our sales and marketing.
We’re extremely excited about the growing size of the team and the people that we’ve recruited. One of the first areas or the additional areas of investment we’ve made is in our leadership.
We announced a couple of weeks ago the creation of a new role, Executive Vice President of Global Sales for Benefitfocus. So we’ll have all of our sales team under one leadership position and we’re really proud to have Robert Dahdah join the team in that capacity, super leader, terrific experience in our industry and leading large teams.
So proud of that. We’re continuing to invest clearly in training and onboarding and equipping our sales team to be the best, most successful sales team in our industry, so a lot of tools and field marketing continuing to go into that team to help them build tenure and success as we go into the second half of the year and 2018.
And then we began to develop additional relationships in the brokerage community late last year with the introduction of our Preferred Partner program and we’ve expanded that in the first half, and particularly in the second quarter we signed some additional national brokerages and regional brokers that I think are going to help particularly in that strategic account space as those employers begin to pick up pace again.
Nandan Amladi
And sort of a follow-up on the same theme, the customers that you have signed up, the 40 new ones that you signed up in the second quarter, do you have enough capacity to bring them live in time for the enrollment season because you took the revenue guidance down effectively by about $10 million from the last guidance that was provided.
Shawn Jenkins
Yes, a bit of a dynamic there. So the quick answer is yes.
Our operational capacity, our engineering team, our implementation team are actually in terrific shape. One of the phenomenons is our implementation cycles have gotten shorter as we’ve gotten our work done quicker and quicker and we’re seeing the benefit of the scale as I’m sure you can see in the rest of the numbers.
But these are the 40 that we signed, they skewed in larger size, so their average deal size is bigger across the board. With the enterprise deals, in particular, same type of cycle we saw last year where many of them will actually go live going into the next year.
So these enterprises implementations not necessarily a Benefitfocus constrain at all, it’s just the larger they are, the more they tend – making it multi-quarter implementation as opposed to a few months. So we have great progress on implementation, no delays there.
The guidance on revenue is merely a fact of just the timing of when these larger ones will go live combined with the delay in those two areas of the carrier, sales activity in the strategic accounts.
Nandan Amladi
Okay, thank you.
Shawn Jenkins
Thank you.
Operator
Thank you. Our next question comes from the line of Brian Peterson with Raymond James.
Please state your question.
Brian Peterson
Hi, thanks guys. So Shawn, I just want to make sure I’m clear on the guidance here.
So taking the $10 million out of the back half of the year, I can understand why bookings may be light given the trends that you mentioned, but as I understand it, what you would’ve booked in 2Q maybe would’ve contributed in the fourth quarter, but probably not in the third quarter. And the guidance still implies that you’re going to be down sequentially.
So is there anything with implementation cycles being extended as well? Just can you help me bridge that gap?
Ray August
Yes, this is Ray. If you look at our Q2 to Q3 sequential revenue, one of the things I talked about in the script was the fact that we accelerated carrier professional services revenue from Q3 to Q2.
One of the things we’re really proud about is the execution of our professional services team and that actually allowed us to complete certain projects early. So what that did was move that professional services revenue into Q2, which created the sequential situation you’re talking about.
Brian Peterson
Okay. So the revision, I guess, in the full year numbers versus the prior outlook that only really would have had an impact on Q4?
Shawn Jenkins
Yes, for the most part. And if you think of the two areas that we’re describing as elongated sales cycles, if you will.
The strategic accounts normally would have seen virtually all of them go live in the current year and we would have recognized their implementation fee in the fourth quarter and their software revenue in the fourth quarter. And so as that pushed into 2018 – those deals push back in the second half of this year, we won’t see that in the fourth quarter.
And we normally would have seen more carrier activity in the second quarter with some of those deals going live as well with the combination of software revenue being turned on in the fourth quarter in addition to professional services. So those two components that had us take down revenue primarily in the fourth quarter.
Brian Peterson
Got it. And just as I think about your visibility going into 2018, what level do you have, I guess, maybe into the fourth quarter ramp because we still see – should see some seasonality there and maybe some of these deals closing into 2018?
Shawn Jenkins
Sure. Our visibility is very good.
Obviously, heading into 2018 with what we know today, we still have second half of the year selling as I described it. We think the carrier selling will be kind of reaccelerated as the carriers will get some knowability.
I think the enterprise team will continue to do good at the back-to-base or our customer community continues to buy in a lot of strength there. With respect to the strategic accounts area, as they prepare for open enrollment, and the sort of the unsettled nature so far on the regulatory environment, we still need to see that get resolved and that strategic accounts team begin to see flow again.
The interesting thing is, our pipeline is terrific at the earlier stages of the pipe with our larger sales team, the work that we’ve done, the product that we’ve developed, it just hasn’t moved through that earlier stage. We haven’t seen the deals get lost.
And if anything that employers are saying, look we just need to delay, we’re going to go through open enrollment one more time on our old way before we move to the cloud. And whether we’ve begin to sign those in the fourth quarter, well, it’s going to be the first part of next year.
We need another – probably another quarter under our belt to determine that.
Brian Peterson
Got it. And maybe I’ll sneak one more in here.
So Ray, the gross margins were really strong this quarter, 55%. Is that the new normal?
I’m just curious what you guys are thinking there?
Ray August
Yes, yes. We appreciate that.
We’re really proud of the gross margin improvement we’ve had over the last several periods and several years. The – when we look at our gross margin improvement and if you were at the One Place Conference, I talked about the things that we had in our plan, what we’re doing in that area and there was a couple of key things.
Perhaps one of the biggest was continued automation of our whole services function. By doing that, that’s allowed us to get a scale and improve and increase our gross margin.
We foresee that increase to continue to occur for the foreseeable future and are real excited about it.
Brian Peterson
Great. Thank you, guys.
Shawn Jenkins
Thank you.
Operator
Thank you. Our next question comes from the line of Frank Sparacino with First Analysis.
Please state your question.
Frank Sparacino
Hi, guys. Shawn, maybe just first, you talked early on about growing sort of partner contribution.
Is there any way to quantify or give us some insight into how that contribution has changed versus a year ago?
Shawn Jenkins
Sure. Yes, our channel, our partners, we continue to invest in that area.
One of the area of strength is both the partnerships are strengthening, the product the way we’ve integrated with our primary channel partners continues to get better and better. I think the outlook for us and our partners continues to increase even with this backdrop of the regulatory environment.
And at Benefitfocus, we’ve invested in more dedicated resources from product standpoint, but also in the sales area. So we have some really talented dedicated channel marketing folks who are developing specific materials, collaborating with our partners to get deeper into their customer base and prospects as well as feet on the street.
So our direct sales force is able to work with our partners in the field and their region, and so we don’t have conflict between our direct team and our channel partners. We’ve added an additional component of regionalized partner feet on the street, if you will, that are helping the partners develop their pipeline and we’re really optimistic about what we’re seeing there.
And just the overall, I think, the view going into 2018 looks good for our partners. Some of it is built to put on the cloud given the dynamic that we just explained, but good relationships and increased investments by our stand out partners.
Frank Sparacino
Can I just focus on the enterprise side for a moment? So the 6 clients you signed in the first half of last year, are – how many of those are actually live today?
Ray August
Yes, all of them are live. We had those as part of our model this year.
So we’re really excited. Each and every one of them is live and using our system and getting value from it today.
Frank Sparacino
And maybe just lastly, and I’ll turn it over to someone else. Why do you think the decision-making in the enterprise side is kind of moving along at a more normal pace than it would be on the strategic smaller employer side of things?
What’s different?
Shawn Jenkins
Yes, good question, very insightful. It’s kind of one of those interesting dynamics where the longer sales cycle of the enterprise is benefiting us in a year like this.
So these enterprise relationships have been developed, many of them starting last year, even prior to that. Our enterprise sales team is also the most tenured sales team.
And so these conversations have been ongoing. And the psychology, if you will, inside the larger enterprises, at least what we’re seeing at Benefitfocus, is they’re kind of already looking past this cycle.
They are buying the Benefitfocus Platform to move to the cloud. It’s a big, long exciting strategic move for them, and so they’ll be implementing Benefitfocus beginning now, but many of them into the first half of 2018.
So they are kind of looking past the noise, if you will, the theatrics in Washington, and they are implementing their consumer strategy, their mobile technologies to get benefit to their employee base and all the other great things that come with using the Benefitfocus Platform. So those relationships are strong.
Interestingly, on the strategic account at the smaller end of the market, these employers – they look at their benefits during the summer generally, analyze them, work with their brokers and, gosh, I mean, just watch the news, for goodness sakes, and all the craziness going on with our inability to make decisions about what the regulations are going to be. Our company, clearly, we – I think we have the right strategy to manage through it and we’ll see reacceleration.
But just as a U.S. citizen, it’s frustrating to see 170 million people covered by these incredible employer benefits and we can’t tell the employers what the rules are going to be for three months from now.
And so those employers, as we’ve seen in the past cycle, do a bit of a pausing. They think about their strategy.
They say, well, we might have to cover, we might not have to cover as many people or the rules might be changed on us and so they go in a bit of a pausing cycle. We did see this in 2010 when the Affordable Care Act came through.
It was a very similar pattern. And once it got resolved, it really isn’t a policy decision.
I think in the economic situation, it’s just a resolution, a clarity, and then we were off to the races again and there was a pretty strong tailwind. So we expect that to happen here again.
But it has affected the lower end of the market more substantially and the carriers for obvious reasons.
Frank Sparacino
Thank you.
Operator
Thank you. [Operator Instructions] Our next question comes from Adam Klauber with William Blair.
Adam Klauber
On the enterprise sales, you said there were over 10,000. Are a number of those over the 25,000 range?
Shawn Jenkins
Yes. Yes, we’ve got several over 20,000, over 50,000 – a couple over 50,000.
So there are some big ones in there. Overall, the average size is up even year-on-year.
So they continue to kind of skew larger.
Adam Klauber
Okay, that’s good. So given that you’re obviously doing well in the enterprise, but the strategic was slow.
On the numbers, if you think on an employee basis, the number of employees coming in, are the larger enterprise clients accounting or I guess mitigating or overcompensating for the lower sales in the strategic?
Shawn Jenkins
Yes, good question. Yes, yes.
Our subscriber – overall subscriber adds, if you will, in the first half are up pretty good, pretty significant, I would say, first half of the year. Caveat that these enterprise customers many won’t go live until 2018, so you got a little bit of a timing dynamic there.
The other thing I would add too, Adam, is that not only the average size getting bigger and the subscriber adds are strong, our attach rates remain very strong and we are selling additional products, the products we introduced at One Place are very popular, consolidated billing, advanced reporting now and independent eligibility verification. So we’ve got a bigger PEPM TAM opportunity for our salespeople to sell, and our customers, particularly the newer ones, these larger ones are attaching multiple of those products.
Adam Klauber
Okay. And can you clarify, you just mentioned that you talked about earlier but just to clarify.
So in strategic sales, when you’re selling – setting up a 2,000 employer, that’s pretty quick. You implement – you get the implementation revenue upfront and then you get some of the software revenue or all the software revenue upfront.
Whereas when you’re signing up the enterprise clients, those get implemented, but you’re probably getting the PEPM throughout 2018. Is that sort of correct?
Shawn Jenkins
Yes, and actually, both of them work the same way. But we recognize the implementation when we go live.
So the strategic, almost all of them, go live in the fourth quarter of this year. So they’re quick to sign up, quick to go live.
You get the 100% of the implementation and the first couple of months of the software subscription. Whereas with the enterprise, many of them won’t go live until 2018, so you won’t see any of the implementation or any of the software revenue until maybe the middle part of 2018.
Ray August
Yes, Adam, and as Shawn said, the software revenue is spread throughout the entire year in both cases are both the same.
Adam Klauber
Right, right. That makes sense.
Okay. And then also on the revenue per employer, the PEPM.
In general, you said the attach rates are going up, particularly the large clients. Can you give us an estimate as you think about the – as you think about going forward?
Is that growing at more like low single-digit, mid-single digit? Just any frame would help us – any frame of reference would help us.
Shawn Jenkins
Yes, I would love to give you all sorts of numbers, but our finance team likes to – we haven’t started reporting these regularly. It’s up, I would say, very nicely and – both the PEPM and the attach rates.
The one number we have talked about attach rates, that’s been consistent and improving as our new customers, for example, over two-thirds of them attach more than one product. Now many of them are attaching three or four, even five of our products upfront.
Another dynamic, Adam, is something about the enterprise space, but the larger the employer, the more they are likely to attach more products, if not all, because they’re coming off either a highly customized ERP or some sort of outsourcing model where they would’ve got years of a pretty broad offering in place and when they moved to Benefitfocus, so we think this is part of what’s helping us win up market as our portfolio of products is so mature now and so strong and broad that they really like to buy, as I said, almost all of our products right upfront.
Adam Klauber
Okay. Thanks a lot.
Operator
Thank you. Our next question comes from the line of John DiFucci with Jefferies.
Please state your question.
Joe Gallo
Hi, guys. This is Joe on for John.
I know it’s tough given the political uncertainty, but you mentioned that you guys had a strong pipeline for next year. Can you talk through the high level, long-term trajectory of both segments, employer and carrier?
Do you guys have – is it just the political uncertainty or do you have the right resources, sales force in place to reaccelerate growth there?
Shawn Jenkins
Yes, good question. With the – I put it in a couple of different areas.
Clearly, enterprise and our customer community are back-to-base teams. We feel like our teams are tenured.
We’ve got the right product, the right messaging and those segments are working very well for us. We have added a lot of folks to our strategic account area that we talked about in the last couple of quarters, kind of second half of last year or first part of this year, first two months.
And we – those strategic accounts generally flow a little quicker than we’ve seen today. Our team this year with these – the impact that I’d say a regulatory uncertainty and the overall tenure of that team is actually down because of the expansion of it.
We’re extremely pleased with the recruiting that we’ve done. We think we’ve got the right team.
We’ve got the right size team. We’ll add just – we’ll add a little bit to that team, but it’s more about tenure build now.
The leadership team that we’ve got in place and the investments we’re making there, real pleased with it. And our carrier team is just stellar.
I mean, they’re just – they’re the best team in the industry. They have great relationships with our carrier customers.
As you can imagine, these carriers are really digesting what their roles are going to be. I think they’ll know what the roles are going to be in the next couple of months for the carriers and I think that team will be really strong.
We’ve got some great new product in our carrier business and the enthusiasm there is good. So I feel very good across the board with the team.
Joe Gallo
That’s helpful. And more of a modeling question.
You guys were easy to model deferred revenue before given those majority professional services, but now as the mix changes and you guys start to invoice annually versus monthly, I was hoping you could kind of talk through that. I know you had previously guided.
I think, it is down $10 million year-over-year. But I was just wondering if that’s still applicable?
And how to think about deferred revenue going forward?
Ray August
Yes, Joe, our deferred revenue does continue to get more sophisticated. There’s a couple of dynamics to be aware of.
The first is, previously, we typically would have a PEPM or we would receive revenue from our customers on a monthly basis. Now we’ve moved that to much more of a PEPY where we’re getting paid upfront.
That’s one of the dynamics, in which you’re seeing an increase in our short-term deferred revenue. However, the most substantial part of our deferred revenue balance today is really deferred revenue from services where we’re recognizing our services revenue over the customer relationship period.
And that’s where you’re seeing the decline where we’re taking that revenue now as we’re recognizing on to our income statement.
Joe Gallo
Is the $10 million – I think, it was $10 million, it might have been $11 million. Is that still applicable for 2017?
Or any help going forward quantitatively?
Ray August
Yes, we really don’t disclose deferred revenue, but it’s something that we’re continuing to work with.
Joe Gallo
Thank you very much.
Operator
Thank you. Our next question comes from the line of Nina Deka with Piper Jaffray.
Please state your question.
Nina Deka
What kind of share are you taking with the new enterprise deal? You mentioned the 15 that you won in the first half of this year.
Is it displacement of some internal function or is it competitive consulting firms or a mixture?
Shawn Jenkins
Yes, great question, Nina. It’s – I would put it as a combination.
It’s – we’re taking share from legacy. And these large enterprises, five – not five, 10 or more years ago, they either implemented an ERP add-on module where they attached a benefits module from their ERP, and in most cases have a highly customized, on-prem capability that really isn’t keeping up with the modern benefits landscape as their mobile capabilities don’t have the analytics, doesn’t do voluntary benefits, for example.
So we are increasingly taking share on the ERP side. And then of course, the outsourcing, the traditional outsourcing model from 10-plus years ago, where call centers primarily some kind of modest website that has a little bit of information or links or PDFs.
And then they’re requiring employees to go to multiple different carrier websites or whatnot. Those two legacy areas are not getting stronger, clearly.
And those large enterprises see Benefitfocus emerging. They love our customer community.
The fact that we now have 893 large employers in the community and all the R&D that we’re putting back into the platform, they see us as the emerging leading platform. Our brand is really growing in that enterprise segment.
Nina Deka
Okay. That’s helpful.
Also, do you include the enterprise accounts in your large employer account?
Shawn Jenkins
Yes. So we have large employer, which is 893 in total.
We began talking about enterprise and strategic as two sub sales teams, if you will. They’re not actual segments that we break out in the reporting, but we do talk to the sales teams.
Nina Deka
Okay, great. And then one last question.
Has anything changed with your visibility on this fiscal year versus your visibility on this year a few quarters ago?
Shawn Jenkins
Well, obviously, we’re in the middle of our selling season – coming through our selling season. And all the things that we’ve described, the environmental things here on the call tonight.
Now that we’re kind of halfway through the selling season, we have a pretty good sense of what the visibility is for the rest of the year. Good news is, the margin improvement, the free cash flow positive in the fourth quarter, tremendous operational scale up and down, the model looks terrific.
It’s just we’ve got to take into account this uncertainty in the political environment and how long it’ll take for those particularly strategic accounts to begin to get back to decision-making.
Nina Deka
Great, thank you. Thanks for the question.
Operator
Thank you. Our next question comes from David Hynes with Canaccord Genuity.
Please state your question.
David Hynes
Hi, thanks guys. So Shawn, we had the Senate vote that kind of put a nail in broad repeal of ACA.
I guess what is it that you need to see from a regulatory standpoint that you think would kind of clear the decks for decision-making?
Shawn Jenkins
Yes, I think that largely was it, David. Those on the call that are wanting to get wonk-ish on all the regulatory environment.
The fact that the House and Senate back and forth were not able to really even get – the final one was the skinny repeal, which is sort of a modest – or is a repeal with more modest changes that fell at 2:00 AM last Friday and they weren’t able to get that through. Most of what you hear and see now is let’s move on, let’s move forward.
I think the community – the benefits community, I think, clearly knows now that they’re going to have an employer mandate. The rules about, for example, covering people with 30 hours or more are going to be in place at least for several more years.
On the carrier side, there’s still – the federal government needs to reassure the carriers that they are going to get these individual subsidies. Even though Benefitfocus is in the employer market, we’re helping carriers, insurance carriers, work with their employer customers, the fact that carriers individual market might be impacted by subsidies or individual mandate, that has to be clarified for them.
They need to do that in the next 1.5 months or two months because the carriers have to file their rates. And so I think that’ll get cleared up here pretty close to – so it’s just a matter of the selling season, the bulk of the energy going into the selling season.
We had this, I call it, theatrics or circus going on that put a pause in there. But we’re pretty certain that it’ll be clear here in the next month or two, and most likely it will be ACA stays intact with some modest changes going forward that will overall be probably seen as pretty positive improvements and a lot of good stuff that will come, I think, as a tailwind for Benefitfocus as that happens.
David Hynes
Yes. And on the employer side.
Have you seen any change in retention? I’m just trying to reconcile kind of the sequential decline in revenue we saw?
I realize the ACA had a year-over-year impact on growth, but I was surprised to see employer revenues go down sequentially.
Shawn Jenkins
Yes, our revenue retention rate is 95% and we’re well above that and we have been above that historically. So that’s remained consistent.
David Hynes
Okay. And then last question.
So Q4 free cash flow profits, I mean, what’s the thought on 2018? Can you be free cash flow profitable for calendar 2018?
Or are we going to wait for Jon to comment on that? What’s your thoughts there?
Shawn Jenkins
I’ll comment on that. I’m Shawn.
I’m the founder of the company. Yes, we plan to be – we’re not guiding to 2018 in any sense of this.
But we’ve said before that we plan once free cash flow positive to remain that. The first quarter is generally a pretty big cash use for the company as we prepay some things.
But for the calendar year 2018, we would plan to be free cash flow positive. That said, we do plan to take – and make ample investments in both product development and sales and marketing to see top line growth reaccelerate, but doing it from a position of strength of free cash flow generation.
Ray August
Yes. And I’d add just from an operational point of view that we’re very, very excited and proud about where we are.
If you look at our gross margin improvements we’ve had there, the improvements in EBITDA profitability that we’re seeing throughout the year and the fact that we actually held a revenue EBITDA guidance range while we had the revenue decline really points to the strength in our EBITDA generation. So we’re excited about free cash flow.
We’re excited about for the end of this year and into the future.
David Hynes
Got it, great. Thanks for your color, guys.
Operator
Thank you. Our next question comes from Ross MacMillan with RBC Capital Markets.
Please state your question.
Ross MacMillan
Well, thanks for squeezing me in. Just had a couple here.
Just on the $10 million revenue reduction for fiscal 2017, could you help us understand the split roughly between software services and professional services?
Ray August
Yes, if you look at it, as Shawn talked about in his comments, really the $10 million is a result of softness in our forecast or our forward-looking selling. And from that point of view, you could expect the software services and professional services revenue to be in line with our traditional percentages and ratios.
Ross MacMillan
Okay, that’s helpful. And then, this was asked, I guess, before around the question on enterprise and the higher number of employees year-over-year, but any way we could think about it on, I don’t know, your employer adds this year were down about 20 versus last year in the first half.
Anyway you could help us bridge to ACB or annualized recurring revenue? If we could see it on an ACB basis, would it be up?
Would it be up materially? That would be helpful.
Shawn Jenkins
Yes. I mean, I think the thing we’ve said, Ross, is the subscriber counts are up year-over-year, so the actual contract values would be up too.
We don’t break out ACV number and give that to you, but the actual subscriber counts are up year-over-year and have been in the last two years. So the average deals are clearly getting larger.
That said, we do expect the strategic accounts to be very positive momentum for Benefitfocus going forward, and I think you’ll see customer accounts will mirror that as we get into 2018, 2019 and beyond.
Ross MacMillan
Understood. And then just pretty impressive job kind of maintaining the EBITDA target for the year.
Where are you investing incrementally less in the second half to get there? What are the areas that you’re maybe investing a little less than the original plan?
Ray August
Yes, when we look at the second half of the year and the continued improvement in both EBITDA and gross margin, that’s really us sticking to the plan that we laid out in the last several years and particularly at our One Place Conference, where we are investing in automation to make sure that we’re as efficient as possible. We’re investing in infrastructure throughout our entire company, whether it be our hardware assets or ERP solution to ensure that we’re increasingly productive.
And the other thing we’ve done is we really had a lot of emphasis on our variable capacity model throughout our services organization where we have a very tight line on and understanding of when we have new customers, what kind of resources we need to serve those customers, what resources we need to serve our existing customers. So that allows us to really have really good insight into our variable cost model.
Ross MacMillan
Thank you.
Operator
Thank you. Our next question comes from Steve Wardell with Chardan Capital.
Please state your question.
Steve Wardell
Hi, there. So my question is that I’m curious about how the selling season is going, where you are selling to your existing clients.
So clients already have at least one product. What kinds of additional products do you seek to sell them?
What are they buying? What trends are you seeing?
Shawn Jenkins
Great. Yes, and that’s really highlighted earlier.
It’s a really great area of strength that we’re seeing in our existing customer base. Our retention is very strong.
And our customer community at Benefitfocus is a really vibrant community. We have an idea community where they can actually submit their own ideas through our platform and we’re building them into the product.
And so a couple that, off the top of my head that we introduced earlier this year that are getting really strong, attach – consolidated billing in particular and something called Direct Pay. So this helps an employer – once they’ve enrolled on the Benefitfocus Platform, take all those bills that they then get from their insurance carriers and consolidate them into a common engine that we’ve built.
We compare that to their payroll system, provide one reconciled bill to the employer and then they can submit one payment amount. It’s a new service for us at Benefitfocus.
It’s extremely well received and very popular. We think it unlocks a tremendous amount of value for the employer because they pay their bills accurately, they remove waste, more timeliness on their cash flow, which is linked to this thing called idea of direct pay, where more and more employees are buying voluntary benefits, benefits they pay for themselves and we now have a payment system, where employee can pay directly from a debit card or ACA account.
If someone’s out on leave, for example, they can continue to benefit through that. Our advanced reporting, we’ve very excited about that, which is a holistic portfolio reporting engine across claims, billing and enrollment eligibility.
And then there’s this service that we have added that’s extremely popular now, dependent eligibility verification, they’re getting a large employer with 3,000, 5,000, 10,000 employees, they have that many dependents or more, and we have a nice service that allows the employee to update their dependent information, send in verification information by taking a picture with their phones. They have a birth certificate or whatnot of one of their children, and the system will automatically verify those dependents.
And when you find folks that are on – are covered that are not eligible, it’s good cost savings for the employer. It helps with claims processing, overall satisfaction, and also helps teach the employees what the plan parameters are and whatnot.
It’s really good for everyone. So those are some of the really new popular services that we have, and we’re excited to see the customer community absorbing them so well.
Steve Wardell
Great. And with the deferred prospects that we’ve been talking about, have any of the companies told you their underlying reasons for pushing off decisions beyond general political unpredictability?
So it is as if they don’t know how many of their employees they’ll be required to cover or is it some other issue like that?
Shawn Jenkins
Yes, that’s a good insight. I would say with the carrier business, it’s very specific to them understanding their underwriting, the subsidies, the dynamic just of their model.
They believe they’ll get resolution on that. As I mentioned, it’s our carrier pipeline and the activity remains very strong.
And we think it’s just a matter of time before those continue to flow. And our strength in the carrier business has, I don’t think, ever been better.
On the employer segment, as you can imagine, in the strategic account area, if you’re in retail, perhaps, the idea of you have to covering 30 people that work 30 hours or more. In this particular labor market, employers are telling us that they would lower their coverage threshold even if the rules change because they’ve got to attract and retain talent.
It’s just a matter of modeling that they’re doing. What other benefits they’ll fit with that, how they’ll fund the benefits and where they’re placing the emphasis, what they’ve got to report to the IRS, for example.
And once you give an employer spending $17 million or $20 million a year, four, five or six or eight variables they’ve got to consider in a market like this, they’ll just pause. They’ll think about it.
They’ll say, hey, look, we’ll make changes next year, and then they – and once they delay for a couple of months, they get into open enrollment cycle. So again, our pipeline remains very strong, but we think it’s just a matter of time for these various reasons.
Steve Wardell
Okay, good. Thank you.
Shawn Jenkins
Thank you.
Operator
That concludes our question-and-answer session. At this time, I will turn it back to your CEO, Shawn Jenkins, for closing comments.
Shawn Jenkins
Terrific. Well, thanks, everybody, for joining our call.
And I want to give an additional shout-out to all our Benefitfocus associates and our incredible customer community. Many of our customers call in to participate in the growth of the company.
We thank you for being our great customers. And to our associates, we’re just so proud of the culture you guys are building, the products and excited about the profitability and all the great things happen at the company.
So thanks so much, and thanks, everyone, for joining us tonight.
Operator
This concludes today’s conference. Thank you for your participation.
You may disconnect your lines at this time.