Attached files

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EX-2.1 - ASSET PURCHASE AGREEMENT - WAGEWORKS, INC.d213653dex21.htm
EX-23.1 - CONSENT OF KPMG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - WAGEWORKS, INC.d213653dex231.htm
EX-10.7 - FORM OF SUBSCRIPTION AGREEMENT - WAGEWORKS, INC.d213653dex107.htm
EX-99.3 - UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION - WAGEWORKS, INC.d213653dex993.htm
EX-23.2 - CONSENT OF MAYER HOFFMAN MCCANN P.C., INDEPENDENT PUBLIC ACCOUNTING FIRM - WAGEWORKS, INC.d213653dex232.htm
EX-21.1 - LIST OF SUBSIDIARIES OF REGISTRANT - WAGEWORKS, INC.d213653dex211.htm
EX-23.3 - CONSENT OF EISNER AMPER LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - WAGEWORKS, INC.d213653dex233.htm
EX-10.10.A - FIRST LOAN MODIFICATION AGREEMENT - WAGEWORKS, INC.d213653dex1010a.htm
EX-10.10.B - SECOND LOAN MODIFICATION AGREEMENT - WAGEWORKS, INC.d213653dex1010b.htm
EX-10.6 - 2012 EMPLOYEE STOCK PURCHASE PLAN - WAGEWORKS, INC.d213653dex106.htm
Table of Contents

As filed with the Securities and Exchange Commission on March 7, 2012

Registration No. 333-173709

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 8

to

Form S-1

REGISTRATION STATEMENT

Under

THE SECURITIES ACT OF 1933

 

 

WAGEWORKS, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   8742   94-3351864

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

  (I.R.S. Employer
Identification Number)

1100 Park Place, 4th Floor

San Mateo, California 94403

(650) 577-5200

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

 

 

Joseph L. Jackson

Chief Executive Officer

1100 Park Place, 4th Floor

San Mateo, California 94403

(650) 577-5200

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

 

 

Copies to:

 

David J. Segre, Esq.

Mark B. Baudler, Esq.

Todd C. Carpenter, Esq.

Wilson Sonsini Goodrich & Rosati,

Professional Corporation

650 Page Mill Road

Palo Alto, CA 94304

(650) 493-9300

  

Kimberly L. Jackson, Esq.

Senior Vice President, General Counsel and Secretary

1100 Park Place, 4th Floor

San Mateo, California 94403

(650) 577-5200

  

Christopher L. Kaufman, Esq.

Tad J. Freese, Esq.

Latham & Watkins LLP

140 Scott Drive

Menlo Park, CA 94025

(650) 328-4600

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

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    (Do not check if a  smaller reporting company)   Smaller reporting company  ¨

 

 

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 prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED MARCH 7, 2012

             Shares

 

LOGO

Common Stock

 

 

This is WageWorks, Inc.’s initial public offering. We are selling              shares of our common stock.

Prior to this offering, there has been no public market for our common stock. The initial public offering price of the common stock is expected to be between $             and $             per share. Our common stock has been approved for listing on the New York Stock Exchange under the symbol “WAGE.”

The underwriters have an option to purchase a maximum of              additional shares to cover over-allotments of shares.

Investing in our common stock involves risks. See “Risk Factors” on page 10.

 

    

Price to
Public

  

Underwriting
Discounts and
Commissions(1)

  

Proceeds to
WageWorks, Inc.

Per Share

   $                $                $            

Total

   $                    $                    $                

 

(1) 

We refer you to “Underwriting” beginning on page 134 for additional information regarding total underwriter compensation.

Delivery of the shares of common stock will be made on or about             , 2012.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

Credit Suisse    William Blair & Company

 

Stifel Nicolaus Weisel    JMP Securities    Needham & Company

The date of this prospectus is                     , 2012.


Table of Contents

LOGO

 

WageWorks®

> Flexible Spending Accounts

> Commuter Benefits

> Health Savings Accounts

> Health Reimbursement Arrangements

> COBRA

Our programs provide material savings to both Employers and Employees – a win-win proposition.

Employees reduce their taxes by participating in FSA, HSA and Commuter programs.

Fantastic.

Just what working families need.

WageWorks®

Health Care Card

4000 1234 5678 9010

4000

GOOD THRU 12/11

JOHN R. SMITH

DEBIT

VISA

WageWorks®

Commuter Card

TRANSIT

5150 4099 9123

5150

Debit

4567

MasterCard

VALID THRU 12/11

JOHN R. SMITH

www.wageworks.com


Table of Contents

 

TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

THE OFFERING

     6   

SUMMARY CONSOLIDATED FINANCIAL DATA

     7   

RISK FACTORS

     10   

INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

     27   

MARKET, INDUSTRY AND OTHER DATA

     27   

USE OF PROCEEDS

     28   

DIVIDEND POLICY

     29   

CAPITALIZATION

     30   

DILUTION

     32   

SELECTED CONSOLIDATED FINANCIAL INFORMATION

     34   

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     38   

BUSINESS

     71   
     Page  

MANAGEMENT

     89   

EXECUTIVE COMPENSATION

     97   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     117   

PRINCIPAL STOCKHOLDERS

     121   

DESCRIPTION OF CAPITAL STOCK

     124   

MATERIAL U.S. FEDERAL INCOME AND ESTATE TAX CONSIDERATIONS FOR NON-U.S. HOLDERS

     128   

SHARES ELIGIBLE FOR FUTURE SALE

     132   

UNDERWRITING

     134   

NOTICE TO CANADIAN RESIDENTS

     141   

LEGAL MATTERS

     143   

EXPERTS

     143   

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     143   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

 

 

You should rely only on the information contained in this prospectus or contained in any related free writing prospectus filed by us with the Securities and Exchange Commission. We have not authorized anyone to provide you with additional information or information that is different from that contained in this prospectus or contained in any related free writing prospectus filed by us with the Securities and Exchange Commission. This document may only be used where it is legal to sell these securities. The information in this document may only be accurate on the date of this document.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information you should consider in making your investment decision. You should read this entire prospectus carefully, especially the risks of investing in our common stock discussed under “Risk Factors” and the consolidated financial statements and related notes included elsewhere in this prospectus, before making an investment decision.

Company Overview

We are a leading on-demand provider of tax-advantaged programs for consumer-directed health, commuter and other employee spending account benefits, or CDBs, in the United States. We administer and operate a broad array of CDBs, including spending account management programs, such as health and dependent care Flexible Spending Accounts, or FSAs, Health Savings Accounts, or HSAs, Health Reimbursement Arrangements, or HRAs, and commuter benefits, such as transit and parking programs.

We deliver our CDB programs through a highly scalable Benefits-as-a-Service, or BaaS, delivery model that employer clients and their employee participants may access through a standard web browser on any internet-enabled device, including computers, smart phones and other mobile devices, such as tablet computers. Our on-demand delivery model eliminates the need for our employer clients to install and maintain hardware and software in order to support CDB programs and enables us to rapidly implement product enhancements across our entire user base.

Our CDB programs enable employees and their families to save money by using pre-tax dollars to pay for certain of their healthcare and commuter expenses. Employers financially benefit from our programs through reduced payroll taxes, even after factoring in our fees. Under our FSA, HSA and commuter programs, employee participants contribute funds from their pre-tax income to pay for qualified out-of-pocket healthcare expenses not fully covered by insurance, such as co-pays, deductibles and over-the-counter medical products or for commuting costs.

These employee contributions result in savings to both employees and employers. As an example, based on our average employee participant’s annual FSA contribution of approximately $1,400 and an assumed personal combined federal and state income tax rate of 35%, an employee participant will reduce his or her taxes by approximately $490 per year by participating in an FSA. Our employer clients also realize payroll tax (i.e., FICA and Medicare) savings on the pre-tax contributions made by their employees. In the above FSA example, an employer client would save approximately $64 per participant per year, even after the payment of our fees.

Under our HRA programs, employer clients provide their employee participants with a specified amount of available reimbursement funds to help their employee participants defray out-of-pocket medical expenses, such as deductibles, co-insurance and co-payments. All amounts paid by the employer into HRAs are deductible by the employer as an ordinary business expense and are tax-free to the employee.

Our clients include 42 of the Fortune 100, 130 of the Fortune 500 and approximately 3,200 small-and-medium-sized business, or SMB, clients. At January 31, 2012, we had approximately 2.0 million employee participants from approximately 5,000 employer clients. We believe that January 31 is the most appropriate point-in-time measurement date for annual plan metrics. Although plan changes and the entry and exit of employers and participants from our programs are usually decided late in the calendar year during open enrollment to be effective on January 1, it is not unusual for employers to still be submitting updated files of participants in early January. While updates can be delayed past January, any changes from such late updates are usually minimal. Consequently, we believe the January 31 point-in-time measurement date is the most appropriate date to use as a baseline. In 2011, employee participants used over two million WageWorks prepaid debit cards. Our revenues are highly diversified, as our largest client represented only 3.0% of our 2011 revenues

 


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and our top 10 clients represented only 14.4% of our 2011 revenues. None of the data included herein reflect the two transactions that we have made in 2012. For a discussion of these transactions, see “—Recent Developments below.

Through a combination of the acquisition and integration of smaller third party administrators, or TPAs, which we refer to as portfolio purchases, and organic growth, we grew our revenue from $108.5 million in 2009 to $115.0 million in 2010 and to $135.6 million in 2011. In each period, our revenue growth resulted primarily from increases in healthcare revenue from portfolio purchases. For each of 2009, 2010 and 2011, clients that accounted for more than 90% of our revenues (excluding interchange fees and vendor commissions) during the year remained under contract with us in the succeeding year. Our net loss was $0.6 million and $17.3 million in the years 2009 and 2010, respectively, and our net income was $33.3 million in 2011. Our Adjusted EBITDA grew from $15.9 million in 2009 to $22.4 million in 2010 and to $30.3 million in 2011, increases of 40% and 36%, respectively. For a discussion of Adjusted EBITDA and a reconciliation of net income (loss) to Adjusted EBITDA, see footnote 2 to “Selected Consolidated Financial Information.”

Industry Overview

Healthcare costs for both employers and employees continue to increase dramatically. To mitigate the continuing rise in healthcare costs, employers are more frequently passing these costs on to employees by increasing deductibles, out-of-pocket limits and non-network provider cost sharing, and by migrating to co-insurance models–systems where employees pay a percentage of the out-of-pocket costs for each healthcare service. As a result, according to a 2011 Hewitt Associates report, average employee out-of-pocket healthcare costs are expected to increase 13.4% from 2011 to 2012.

In addition, rising transportation costs and increasing corporate social responsibility have led to the creation of a variety of programs that are aimed at helping employees understand and reduce their carbon footprint by encouraging alternatives to driving to work. These alternatives include carpooling, cycling and use of public transportation. According to a 2011 American Public Transportation Association report, public transportation is twice as fuel efficient as private automobiles at reducing annual fuel consumption.

CDBs have emerged as an attractive way for employers to offer structured benefit plans to their employees that lessen overall healthcare and transportation costs through the use of tax-advantaged spending accounts.

Employee-funded tax-advantaged spending accounts include:

 

   

FSAs, which allow employees to set aside a portion of earnings on a pre-tax basis to pay for certain expenses primarily related to healthcare, but also cover dependent care, vision and dental expenses;

 

   

HSAs, which allow employees to set aside pre-tax earnings for similar expenses, but are available only to individuals who are enrolled in a qualified High Deductible Health Plan; and

 

   

Commuter accounts, which allow employee participants to set aside earnings on a pre-tax basis to cover commuter rail, subway, bus, commuter-related parking and eligible vanpool expenses.

Employer-funded tax-advantaged spending accounts include:

 

   

HRAs, which allow employer clients to provide their employee participants with a specified amount of available reimbursement funds to help their employee participants defray out-of-pocket medical expenses, such as deductibles, co-insurance and co-payments. All amounts paid by the employer into HRAs are deductible by the employer as an ordinary business expense and are tax-free to the employee.

Our CDB Programs

We focus on providing CDB programs to employer clients of any size. We provide marketing programs that are designed to increase employee participation in our employer clients’ CDB offerings. We believe our employer

 

 

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clients and their employee participants benefit from our superior customer service, efficient workflow processes and advanced monitoring applications. The quality of our customer support has resulted in high levels of client satisfaction and service level performance. We employ a wide range of sophisticated tools to communicate available benefit options to employees and measure the effectiveness of CDB program performance.

We deliver our CDB programs through a BaaS model under which we host and maintain the benefits programs that we provide to our employer clients. Our on-demand delivery model enables employer clients and their employee participants to implement, access and use our proprietary software remotely through a standard web browser on any internet-enabled device, including computers, smart phones and other mobile devices, such as tablet computers. We believe that our on-demand model requires less up-front investment by our employer clients than required by traditional third-party software and hardware options, as well as less personnel resources and implementation services.

Key Business Attributes

Key attributes of our business include the following:

 

   

Our revenue is derived almost entirely from recurring monthly fees paid by our employer clients.

 

   

Our focus is to consistently deliver the highest quality service to our employer clients and their employee participants, which primarily means providing employee participants with timely and accurate responses to their inquiries, claims submissions and other account transactions.

 

   

Our CDB programs employ an easy-to-use website interface that provides our employer clients with robust data and reporting capabilities and provides employee participants with direct access to their accounts, claims history and balance information.

 

   

We have historically successfully identified and executed portfolio purchases and integrated the operations of these complementary businesses to expand our employer client base. While we have encountered some challenges in integrating accounting functions in connection with certain of these portfolio purchases, we have leveraged the efficiencies afforded by our on-demand software platform to cross-sell additional CDB products and services to acquired employer clients. We expect to experience similar effects from our recent acquisition that we completed in early 2012.

 

   

Our senior management team has significant operating and service delivery experience with industry-leading businesses.

 

   

We have a large and highly diversified employer client base.

 

   

Our core business is providing a comprehensive array of full-featured CDB programs to employers.

Our Strategy

Our objective is to enhance our position as a leading provider of CDB account management programs. The key elements of our growth strategy are to:

 

   

increase employee participation levels within our existing employer client base;

 

   

cross-sell additional CDB programs to our existing employer clients;

 

   

broaden our employer client base through portfolio purchases;

 

   

gain market share with both Fortune 1000 companies and SMBs by leveraging our multiple sales channels; and

 

   

continually enhance our products and develop new products and functionality.

 

 

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Recent Developments

On January 3, 2012, we completed a portfolio purchase in which we acquired all of the operating assets of The Choice Care Card, LLC, also known as Choice Strategies, or CS, a third party administrator of predominantly SMB HRA accounts, based in Vermont. CS added approximately 5,100 employer clients, primarily in New England, to our business.

On February 1, 2012, we acquired all of the operating assets of TransitCenter, Inc., a New York-based not for profit entity that conducted a business that we refer to as TransitChek, or TC, that provided commuter benefit services to approximately 10,000 predominantly SMB employer clients in the New York tri-state area. The acquisition of TC enabled us to further expand our commuter tax-advantaged benefit offerings in the SMB market with products tailored to SMB needs. We believe this acquisition will help solidify our position as a leading provider of commuter-related CDBs.

The consideration for these two transactions totaled $39.9 million. Of this amount, $39.1 million was paid in January and February 2012. These payments were primarily financed through our revolving credit facility with Union Bank, N.A. There are additional possible contingent payments due in 2012 and 2013 based on the achievement of certain revenue levels. We currently anticipate that the future contingent payments for these two transactions will total approximately $14 million to $16 million. However, this estimate is preliminary and may change, potentially materially, based on the actual revenue milestones achieved.

Risks Affecting Us

Our business is subject to a number of risks that you should understand before making an investment decision. These risks are discussed more fully in “Risk Factors” following this prospectus summary. Some of these risks include the following:

 

   

any diminution in, elimination of, or change in the availability of, tax-advantaged consumer-directed benefits to employees would materially adversely affect our results of operations, financial condition, business and prospects;

 

   

our ability to grow our business could be materially adversely affected if we fail to successfully identify, acquire or integrate additional portfolio purchase or acquisition targets;

 

   

our business may not grow if our marketing efforts do not successfully raise awareness among employers and employees about the advantages of adopting and participating in CDB programs;

 

   

our results of operations, financial condition, business and prospects would be materially adversely affected if we are unable to retain and expand our employer client base;

 

   

our business may not grow if a greater percentage of employees do not participate in our employer clients’ CDB programs;

 

   

our business and prospects may be materially adversely affected if we are unable to cross-sell our products and services;

 

   

we may be unable to compete effectively against our current and future competitors; and

 

   

we may not accurately estimate the impact of the development and introduction of new products and services on our business.

Risks Related to this Offering and Ownership of Our Common Stock

There are risks related to this offering and the ownership of our common stock that you should understand before making an investment decision, including that, following the completion of this offering and assuming no exercise by the underwriters of their overallotment option, VantagePoint Capital Partners will hold approximately         % of our common stock and will have the right to designate three members of our board of

 

 

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directors, as well as other rights, which may limit the ability of our public stockholders to affect significant corporate actions. These risks are discussed more fully in “Risk Factors” following this prospectus summary.

Corporate Information

We were incorporated in Delaware in 2000. Our principal executive offices are located at 1100 Park Place, 4th Floor, San Mateo, CA 94403, U.S.A., and our telephone number is 1 (650) 577-5200. Our website address is www.wageworks.com. Information contained on our website is not incorporated by reference into this prospectus, and should not be considered to be part of this prospectus.

“WageWorks,” “Commuter Express,” “WinFlexOne,” “Fringe Benefits Management Company,” “Choice Strategies,” “TransitChek” and other trademarks, service marks or trade names of WageWorks appearing in this prospectus are the property of WageWorks, Inc. Other service marks, trademarks and trade names referred to in this prospectus are the property of their respective owners.

 

 

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The Offering

 

Common stock offered by us

             shares

 

Common stock to be outstanding after this offering

             shares

 

Overallotment option

The underwriters have an option to purchase a maximum of              additional shares of common stock from us to cover overallotments. The underwriters could exercise this option at any time within 30 days from the date of the prospectus.

 

Use of proceeds

We intend to use the net proceeds received by us from this offering for working capital, including funding of customer obligations, and general corporate purposes, including further expansion of our sales and marketing efforts, continued investments in technology and development and for capital expenditures. In addition, we may use a portion of the proceeds of this offering for portfolio purchases or purchases of technologies or assets to expand our employer client base. However, we do not have agreements for any portfolio purchases at this time. See “Use of Proceeds.”

 

NYSE trading symbol

“WAGE”

The number of shares of common stock that will be outstanding after this offering is based on the number of shares outstanding as of December 31, 2011 and excludes:

 

   

4,539,860 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2011, at a weighted average exercise price of $7.29 per share;

 

   

75,000 shares of common stock issuable upon the exercise of a warrant outstanding as of December 31, 2011 to purchase common stock, at an exercise price of $8.20 per share;

 

   

4,578,567 shares of common stock, on an as-converted basis and assuming the conversion occurs immediately prior to the completion of this offering, issuable upon the exercise of warrants outstanding as of December 31, 2011 to purchase convertible preferred stock, at a weighted average exercise price of $4.76 per share; and

 

   

474,940 shares of common stock reserved for future issuance under our 2010 Equity Incentive Plan as of December 31, 2011.

All information in this prospectus reflects a 1-for-2 reverse stock split of our outstanding common stock effected on July 15, 2011.

Unless otherwise indicated, all information in this prospectus assumes:

 

   

the conversion of all outstanding shares of our convertible preferred stock into an aggregate of 17,687,612 shares of common stock, effective upon the completion of this offering, except with respect to historical financial information; and

 

   

no exercise by the underwriters of their overallotment option to purchase up to              additional shares of common stock from us.

 

 

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Summary Consolidated Financial Data

The information set forth below should be read together with “Capitalization,” “Selected Consolidated Financial Information,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

The summary consolidated statements of operations data for the years ended December 31, 2009, 2010 and 2011 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. The following summary consolidated financial data table reflects the 1-for-2 reverse stock split of our outstanding common stock effected on July 15, 2011. Historical results are not necessarily indicative of the results to be expected in the future.

 

     Year Ended December 31,  
     2009     2010     2011  
     (in thousands, except per share data)  
                    

Consolidated Statement of Operations Data:

      

Revenues

   $ 108,461      $ 115,047      $ 135,637   

Operating expenses

     107,992        107,013        122,077   
  

 

 

   

 

 

   

 

 

 

Income from operations

     469        8,034        13,560   

Interest and other expense, net

     (608     (26,488     (107
  

 

 

   

 

 

   

 

 

 

Income (loss) before taxes

     (139     (18,454     13,453   

Income tax (provision) benefit

     (495     1,204        19,868   
  

 

 

   

 

 

   

 

 

 

Net income (loss)

     (634     (17,250     33,321   

Accretion of redemption premium (expense) benefit

     1,037        (6,740     (6,209
  

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common stockholders

   $ 403      $ (23,990   $ 27,112   
  

 

 

   

 

 

   

 

 

 

Net income (loss) per share attributable to common stockholders:

      

Basic

   $ 0.25      $ (15.70   $ 17.65   

Diluted

   $ (0.04   $ (15.70   $ 1.43   

Weighted Average Shares:

      

Basic

     1,606        1,528        1,536   

Diluted

     16,864        1,528       
20,086
  

Pro forma net income per share attributable to common stockholders (unaudited):

      

Basic(1)

       $ 1.72   

Diluted(1)

       $ 1.45   

Pro forma weighted average shares outstanding used in computing net income per share attributable to common stockholders (unaudited):

      

Basic(1)

        
19,224
  

Diluted(1)

        
22,734
  

 

(1) See Note 2 to our consolidated financial statements for an explanation of the method used to calculate the unaudited pro forma basic and diluted net income per share for the year ended December 31, 2011. All shares to be issued in the offering were excluded from the unaudited pro forma basic and diluted net income per share calculation.

 

 

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     At December 31,  
     2009     2010     2011  
     (in thousands)  
                    

Consolidated Balance Sheet Data:

      

Cash and cash equivalents

   $ 93,261      $ 104,280      $ 154,621   

Total current assets

     108,515        124,337        179,829   

Total assets

     171,478        206,831        278,696   

Total current liabilities

     153,303        167,648        215,645   

Total liabilities

     167,430        182,254        218,584   

Total redeemable convertible preferred stock

     48,043        75,960        82,169   

Total stockholders’ deficit

     (43,995     (51,383     (22,057

 

     Years Ended December 31,  
     2009      2010      2011  
     (in thousands)  

Non-GAAP Financial Data:

        

Adjusted EBITDA (unaudited)

   $ 15,941       $ 22,366       $ 30,330   

Notes to Summary Balance Sheet Data and Other Data

Definition of Adjusted EBITDA

Adjusted EBITDA is a performance measure that is not calculated in accordance with GAAP. The table immediately following this discussion provides a reconciliation of net income (loss) to Adjusted EBITDA, which is the most directly comparable GAAP measure. Adjusted EBITDA should not be considered as an alternative to net income, income from operations or any other measure of financial performance calculated and presented in accordance with GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of other companies because other companies may not calculate Adjusted EBITDA or similarly titled measures in the same manner that we do. We prepare Adjusted EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. We encourage you to evaluate these adjustments, the reasons we consider them appropriate and the material limitations of Adjusted EBITDA as described in footnote 2 to “Selected Consolidated Financial Information.”

Our management uses Adjusted EBITDA:

 

   

as a measure of operating performance;

 

   

as a factor when determining management’s compensation;

 

   

for planning purposes, including the preparation of our annual operating budget;

 

   

to allocate resources of our business; and

 

   

to evaluate the effectiveness of our business strategies.

We believe that the use of Adjusted EBITDA provides consistency and comparability with our past financial performance and facilitates period-to-period comparisons of our operating results by management and investors. Although calculation of Adjusted EBITDA may vary from company-to-company, our detailed presentation may facilitate analysis and comparison of our operating results by management and investors with other peer companies, many of which use similar non-GAAP financial measures to supplement their GAAP results in their public disclosures.

 

 

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Reconciliation of Net Income (Loss) to Adjusted EBITDA

The following provides a reconciliation of net income (loss) to Adjusted EBITDA:

 

     Year Ended December 31,  
     2009     2010     2011  
     (in thousands)  
     (unaudited)  

Net income (loss)

   $ (634   $ (17,250   $ 33,321   

Depreciation

     4,564        4,164        3,199   

Amortization and change in contingent consideration

     8,398        7,764        11,327   

Stock-based compensation expense

     2,510        2,404        2,244   

Interest income

     (851     (220     (36

Interest expense

     1,102        188        494   

Interest expense: amortization of convertible debt discount

     71        21,107        —     

Income tax provision (benefit)

     495        (1,204     (19,868

Loss (gain) on revaluation of warrants

     (70     5,413        (351

Loss on extinguishment of debt

     356        —          —     
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 15,941      $ 22,366      $ 30,330   
  

 

 

   

 

 

   

 

 

 

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this prospectus, including our consolidated financial statements and related notes included elsewhere in this prospectus, before making an investment decision. If any of the following risks is realized, our business, financial condition, results of operations and prospects could be materially and adversely affected. In that event, the trading price of our common stock could decline and you could lose part or all of your investment.

Risks Related to Our Business and Industry

Our business is dependent upon the availability of tax-advantaged consumer-directed benefits to employers and employees and any diminution in, elimination of, or change in the availability of, these benefits would materially adversely affect our results of operations, financial condition, business and prospects.

Our business fundamentally depends on employer and employee demand for tax-advantaged consumer-directed health, commuter and other employee spending plan benefits, or CDBs. We are not aware of any reliable statistics on the growth of CDB programs and cannot assure you that participation in CDB programs will grow. Any diminution in or elimination of the availability of CDBs for employees would materially adversely affect our results of operations, financial condition, business and prospects. In addition, incentives for employers to offer CDBs may also be reduced or eliminated by changes in laws that result in employers no longer realizing financial gain from the implementation of these benefits. If employers cease to offer CDB programs or reduce the number of programs they offer to their employees, our results of operations, financial condition, business and prospects would also be materially adversely affected.

In addition, if the payroll tax savings employers currently realize from their employees’ utilization of CDBs become reduced or unavailable, employers may be less inclined to offer these programs to their employees. If the tax savings currently realized by employee participants by utilizing CDBs were reduced or unavailable, we expect employees would correspondingly reduce or eliminate their participation in such CDB plans. Any such reduction in employer or employee incentives would materially adversely affect our results of operations, financial condition, business and prospects.

Future portfolio purchases and acquisitions are an important aspect of our growth strategy, and any failure to successfully identify, acquire or integrate acquisitions or additional portfolio targets could materially adversely affect our ability to grow our business. In addition, costs of integrating acquisitions and portfolio purchases may adversely affect our results of operations in the short term.

Our recent growth has been, and our future growth will be, substantially dependent on our ability to continue to make and integrate acquisitions and complementary portfolio purchases to expand our employer client base and service offerings. Since 2007, we have completed five portfolio purchases and one acquisition, including one portfolio purchase and one acquisition in 2012. The successful integration of these portfolio purchases and acquisitions into our operations on a cost-effective basis is also critical to our future financial performance. While we believe that there are numerous potential portfolio purchases that would add to our employer client base and service offerings, we cannot assure you that we will be able to successfully make a sufficient number of such portfolio purchases in a timely and effective manner in order to support our growth objectives. In addition, the process of integrating portfolio purchases and our most recent acquisition may create unforeseen difficulties and expenditures. We face various risks in making portfolio purchases and any acquisition, including:

 

   

our ability to retain acquired employer clients and their associated revenues;

 

   

diversion of management’s time and focus from operating our business to address integration challenges;

 

   

our ability to retain or replace key employees from acquisitions and portfolios we acquire;

 

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cultural and logistical challenges associated with integrating employees from acquired portfolios into our organization;

 

   

our ability to integrate the combined products, services and technology;

 

   

the migration of acquired employer clients to our technology platforms;

 

   

our ability to cross-sell additional CDB programs to acquired employer clients;

 

   

our ability to realize expected synergies;

 

   

the need to implement or improve internal controls, procedures and policies appropriate for a public company at businesses that, prior to the portfolio purchase or acquisition, may have lacked effective controls, procedures and policies, including, but not limited to, processes required for the effective and timely reporting of the financial condition and results of operations of the acquired business, both for historical periods prior to the acquisition and on a forward-looking basis following the acquisition;

 

   

possible write-offs or impairment charges that result from acquisitions and portfolio purchases;

 

   

unanticipated or unknown liabilities that relate to purchased businesses;

 

   

the need to integrate purchased businesses’ accounting, management information, human resources, and other administrative systems to permit effective management; and

 

   

any change in one of the many complex federal or state laws or regulations that govern any aspect of the financial or business operations of our business and businesses we acquire, such as state escheatment laws.

Portfolio purchases and acquisitions may have a short-term material adverse impact on our results of operations, including a potential material adverse impact on our cost of revenues, as we seek to migrate acquired employer clients to our proprietary technology platforms, typically over the succeeding 12 to 24 months, in order to achieve additional operating efficiencies. For example, our cost of revenues in the fourth quarter of 2010 included additional expenses of $1.8 million due to the purchases of Planned Benefit Systems, or PBS, and the CDB assets of a division of Fringe Benefits Management Company, or FBM. We expect an increase in the dollar amount of cost of revenues in 2012 related to our CS and TC transactions.

Our business may not grow if our marketing efforts do not successfully raise awareness among employers and employees about the advantages of adopting and participating in CDB programs.

Our revenue model is substantially based on the number of employee participants enrolled in the CDB programs that we administer. We devote significant resources to educating both employers and their employees on the potential cost savings available to them from utilizing CDB programs. We have created various marketing, educational and awareness tools to inform employers about the benefits of offering CDB programs to their employees and how our services allow them to offer these benefits in an efficient and cost effective manner. We also provide marketing information to employees that informs them about the potential tax savings they can achieve by utilizing CDB programs to pay for their healthcare, commuter and other benefit needs. However, if more employers and employees do not both become aware of or understand these potential cost savings and choose to adopt CDB programs, our results of operations, financial condition, business and prospects may be materially adversely affected.

If we are unable to retain and expand our employer client base, our results of operations, financial condition, business and prospects would be materially adversely affected.

Most of our revenue is derived from the long term, multi-year agreements that we typically enter into with our employer clients. The initial subscription period is typically three years for our larger employer clients, which we refer to as enterprise clients, and one year for our small- and medium-sized business, or SMB, clients. Our employer clients, however, have no obligation to renew their agreements with us after the initial term and we

 

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cannot assure you that our employer clients will continue to renew their agreements at the same rate, if at all. Moreover, most of our employer clients have the right to cancel their agreements for convenience, subject to certain notice requirements. While few employer clients have terminated their agreements with us for convenience, some of our employer clients have elected not to renew their agreements with us. Our employer clients’ renewal rates may decline or fluctuate as a result of a number of factors, including the prices of competing products or services or reductions in our employer clients’ spending levels. If our employer clients do not renew their agreements with us, and we are unable to attract new employer clients, our revenue may decline and our results of operations, financial condition, business and prospects may be materially adversely affected.

Our business may not grow if a greater percentage of employees do not participate in our employer clients’ CDB programs.

Our revenue depends on the number of employees who participate in the CDB programs that we sell to our employer clients. If more employees do not participate in these benefit programs for various reasons, including a lack of information about the tax-related advantages of doing so, insufficient funds to set aside pre-tax income into such programs, concerns about forfeiting contributions due to forfeiture provisions in FSA benefit programs, or otherwise, our business may not grow as we anticipate and that may materially adversely affect our results of operations, financial condition, business and prospects.

Our business and prospects may be materially adversely affected if we are unable to cross-sell our products and services.

A significant component of our growth strategy is the increased cross-selling of products and services to current and future employer clients. In particular, we expect our ability to cross-sell our commuter programs to our healthcare program clients and our healthcare programs to our commuter employer clients to be an important part of this strategy. We may not be successful in cross-selling our products and services if our employer clients find our additional products and services to be unnecessary or unattractive. Any failure to sell additional products and services to current and future clients could materially adversely affect our results of operations, financial condition, business and prospects.

We may be unable to compete effectively against our current and future competitors.

The market for our products and services is highly competitive, rapidly evolving and fragmented. We have numerous competitors, including health insurance carriers, such as Aetna and UHC, human resources consultants and outsourcers, such as Aon Hewitt, payroll providers, such as ADP and Ceridian, national CDB specialists, such as TASC and SHPS, regional third party administrators and commercial banks, such as Bank of America. Many of our competitors, including health insurance carriers, have longer operating histories and significantly greater financial, technical, marketing and other resources than we do. As a result, some of these competitors may be in a position to devote greater resources to the development, promotion, sale and support of their products and services.

In addition, if one or more of our competitors were to merge or partner with another of our competitors, the change in the competitive landscape could materially adversely affect our ability to compete effectively. Our competitors may also establish or strengthen cooperative relationships with our current or future strategic brokers, insurance carriers, payroll services companies, third party advisors or other parties with which we have relationships, thereby limiting our ability to promote our CDB programs with these parties and limiting the number of brokers available to sell or market our programs. If we are unable to compete effectively with our competitors for any of the foregoing reasons or for any other reasons, our results of operations, financial condition, business and prospects could be materially adversely affected.

 

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We plan to extend and expand our products and services and introduce new products and services, and we may not accurately estimate the impact of developing and introducing these products and services on our business.

We intend to continue to invest in technology and development to create new and enhanced products and services to offer our employer clients and their participating employees. For example, in 2011, we deployed a mobile application that enables employee participants to access their accounts and submit healthcare and dependent care claims as well as healthcare debit card receipts. Employee participants can securely send digital photos of their receipts to verify expenses and debit card transactions directly from their iPhone®, iPad®, Android and Blackberry® devices. We have limited experience in these areas, however, and we may not be able to anticipate or manage new risks and obligations or legal, compliance or other requirements that may arise. In addition, the anticipated benefits of these expanded products and services may not outweigh the costs and resources associated with their development.

Our ability to attract and retain new employer clients and increase revenue from existing employer clients will depend in large part on our ability to enhance and improve our existing products and services and to introduce new products and services. The success of any enhancement or new product or service depends on several factors, including the timely completion, introduction and market acceptance of the enhancement or new product or service. Any new product or service we develop or acquire may not be introduced in a timely or cost-effective manner and may not achieve the broad market acceptance necessary to generate significant revenue. If we are unable to successfully develop or acquire new products or services or enhance our existing products or services to meet client requirements, our results of operations, financial condition, business or prospects may be materially adversely affected.

If the market for our services does not grow as we anticipate, our results of operations, financial condition, business and prospects may be materially adversely affected.

Our future success depends on increasing the number of employer clients and their employee participants to whom we provide our services. However, there is no guarantee that the market for our services will grow as we expect. For example, the value of our services is directly related to the complexity of administering CDB programs and government action that significantly reduces or simplifies these requirements could reduce demand or pricing for our services. If the market for our services declines or develops more slowly than we expect, or the number of employer clients that select us to provide CDB programs to their employee participants declines or fails to increase as we expect, our revenue, results of operations, financial condition, business and prospects could be materially adversely affected.

General economic and other conditions may adversely affect trends in employment and hiring patterns, which could result in lower employee participation in CDB programs, which would materially adversely affect our results of operations, financial condition, business and prospects.

Our revenue is attributable to the number of employee participants at each of our employer clients, which in turn is influenced by the employment and hiring patterns of our employer clients. To the extent that weak economic conditions cause our employer clients to freeze or reduce their headcount or wages paid, demand for our programs may decrease, which could materially adversely affect our results of operations, financial condition, business and prospects. Similarly, our revenue growth opportunities may be negatively affected by such headcount or wage reductions by our potential employer clients.

 

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Our business and prospects may be materially adversely affected if we are unable to maintain high levels of service while reducing operating costs.

One of the key attributes of our business is providing high quality service to our employer clients and their employee participants. While we have exceeded contractual service levels to our enterprise employer clients each month since May 2007, as our business grows and we service increasing numbers of employer clients and their employee participants, we may be unable to sustain these same levels of service, which could have a material adverse effect on our business. Alternatively, we may only be able to sustain high levels of service by significantly increasing our operating costs, which would materially adversely affect our operating results. If we are unable to maintain these high levels of service performance, our brand and reputation could suffer and our results of operations, financial condition, business and prospects would be materially adversely affected.

Failure to effectively develop and expand our direct and indirect sales channels may materially adversely affect our results of operations, financial condition, business and prospects and reduce our growth.

We will need to continue to expand our sales and marketing infrastructure in order to grow our employer client base and our business. We rely on our enterprise sales force to target new Fortune 1000 client accounts, as well as to cross-sell additional products and services to our existing enterprise clients. Effectively training our sales personnel requires significant time, expense and attention. In addition, we utilize various channel brokers, including insurance agents, benefits consultants, regional and national insurance carriers, health plans, payroll companies, banks and regional TPAs, to sell and market our programs to SMB employers. If we are unable to develop and expand our direct sales teams or these indirect sales channels, our ability to attract new employer clients and cross-sell our programs may be negatively impacted and our growth opportunities will be reduced, each of which would materially adversely affect our results of operations, financial condition, business and prospects.

If our efforts to develop and expand our direct and indirect sales channels do not generate a corresponding increase in revenue, our business may be materially adversely affected. In particular, if we are unable to effectively train our sales personnel or if our direct sales personnel are unable to achieve expected productivity levels in a reasonable period of time, we may not be able to increase our revenue and grow our business.

Long sales cycles make the timing of our long-term revenues difficult to predict.

Our sales cycle generally varies in length between two and nine months and, in some cases, even longer depending on the size of the potential client. Factors that may influence the length of our sales cycle include:

 

   

the need to educate potential employer clients about the uses and benefits of our CDB programs;

 

   

the relatively long duration of the commitment clients make in their agreements with us or with pre-existing plan administrators;

 

   

the discretionary nature of potential employer clients’ purchasing and budget cycles and decisions;

 

   

the competitive nature of potential employer clients’ evaluation and purchasing processes;

 

   

fluctuations in the CDB program needs of potential employer clients; and

 

   

lengthy purchasing approval processes of potential employer clients.

The fluctuations that result from the length of our sales cycle may be magnified for large- and mid-sized potential employer clients. If we are unable to close an expected significant transaction with one or more of these potential clients in the anticipated period, our operating results for that period, and for any future periods in which revenue from such transaction would otherwise have been recognized, would be harmed.

 

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Our business and operational results are subject to seasonality as a result of open enrollment for CDB programs and decreased use of commuter program offerings during typical vacation months.

The number of accounts that generate revenue is typically greatest during our first calendar quarter due primarily to three factors. First, new employer clients and their employee participants typically begin service on January 1. Second, during the first calendar quarter, we are also servicing the end of plan year activity for existing clients and employee participants who do not continue participation into the next plan year. Third, we receive the majority of cash for pre-funded accounts from our employer clients in late December or early January, which results in higher cash balances during our first quarter.

Generally, in comparison to other quarters, our revenue is highest in the first quarter and lowest in the second and third quarters. Thereafter, our revenue generally grows gradually in the fourth quarter as our employer clients hire new employees who then elect to participate in our programs, thereby increasing our monthly minimum billing amount. The minimum billing amount is not, however, generally subject to downward revision when employees leave their employers because we continue to administer those former employee participants’ accounts for the remainder of the plan year. Revenue from commuter programs may vary from month-to-month because employees may elect to participate in our commuter programs at any time during the year and may change their election to participate or the amount of their contribution on a monthly basis; however, participation rates in our commuter business typically slow during the summer as people take vacations and do not purchase transit passes or parking passes during that time.

Our operating expenses increase during the fourth quarter because we increase our customer support center capacity to answer questions from employee participants during the open enrollment periods related to their CDB participation decisions. The cost of providing services peaks in the first quarter as new employee participants contact us for information about their CDBs, and as terminating employee participants submit their final claims for reimbursement.

If employee participants do not continue to utilize our prepaid debit cards, our results of operations, business and prospects could be materially adversely affected.

We derive a portion of our revenue from interchange fees that are paid to us when employee participants utilize our prepaid debit cards to pay for certain healthcare and commuter expenses under CDB programs. These fees represent a percentage of the expenses transacted on each debit card. If our employer clients do not adopt these prepaid debit cards as part of the benefits programs they offer, if the employee participants do not use them at the rate we expect, or if other alternatives to prepaid tax-advantaged benefit cards develop, our results of operations, business and prospects could be materially adversely affected.

If we are unable to maintain and enhance our brand and reputation, our ability to sustain and grow our business may be materially adversely affected.

Maintaining and strengthening our brand is critical to attracting new clients and growing our business. Our ability to maintain and strengthen our brand and reputation will depend heavily on our capacity to continue to provide high levels of customer service to our employer clients and their employee participants at cost effective and competitive prices, which we may not do successfully. In addition, our continued success depends, in part, on our reputation as an industry leader in promoting awareness and understanding of the positive impact of CDBs among employers and employees. If we fail to successfully maintain and strengthen our brand, our results of operations, financial condition, business and prospects will be materially adversely affected.

Some plan providers with which we have relationships also provide, or may provide, competing services.

We face competitive risks in situations where some of our strategic partners are also current or potential competitors. For example, certain of the banks we utilize as custodians for our prepaid debit card funds also offer

 

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their own HSA products. To the extent that these partners choose to offer competing products and services that they have developed or in which they have an interest to our current or potential clients, our results of operations, business and prospects could be materially adversely affected.

We are subject to complex regulation, and any compliance failures or regulatory action could materially adversely affect our business.

The plans we administer and, as a result, our business are subject to extensive, complex and continually changing federal and state laws and regulations, including IRS regulations, ERISA, privacy and HIPAA regulations and Department of Labor regulations, all of which are further described in “Business—Government Regulation” below. If we fail to comply with any applicable law, rule or regulation, we could be subject to fines and penalties, indemnification claims by our clients, or become the subject of a Department of Labor enforcement action, each of which would materially adversely affect our business and reputation.

We may also become subject to additional regulatory and compliance requirements as a result of changes in laws or regulations, or as a result of any expansion or enhancement of our existing products and services or any new products or services we may offer in the future. For example, if we expand our product and service offerings into the health insurance market in the future, we would become subject to state Department of Insurance regulations. Compliance with any new regulatory requirements may divert internal resources and take significant time and effort.

Any claims of noncompliance brought against us, regardless of merit or ultimate outcome, could subject us to investigation by the Department of Labor, the Internal Revenue Service, the Centers for Medicare and Medicaid Services, the Treasury Department or other federal and state regulatory authorities, which could result in substantial costs to us and divert management’s attention and other resources away from our operations. In addition, investor perceptions of us may suffer and could cause a decline in the market price of our common stock. Our compliance processes may not be sufficient to prevent assertions that we failed to comply with any applicable law, rule or regulation.

Changes in healthcare laws and other regulations applicable to our business may constrain our ability to offer our products and services.

Changes in healthcare or other laws and regulations applicable to our business may occur that could increase our compliance and other costs of doing business, require significant systems enhancement, or render our products or services less profitable or obsolete, any of which could have a material adverse effect on our results of operations. For instance, when the new debit card network exclusivity restrictions set forth in the Durbin Amendment to the Electronic Fund Transfer Act are implemented in April 2013, we will be required to use at least two unaffiliated networks for our prepaid debit cards and the card issuers and networks may pass a portion of the implementation costs of such changes to us. While we do not currently expect that this will have, or is reasonably likely to have, a material adverse impact on our financial condition or operating results, we will need to continue to monitor the status of this rule as well as other potential changes in laws or regulations that may impact our business as such changes could potentially adversely affect our business, prospects and results of operations.

There has been an increasing political and regulatory focus on healthcare laws in recent years. While legislation such as the Patient Protection and Affordable Care Act has been signed into law, many of the details necessary to implement the legislation have yet to be defined. For example, any new laws that increase reporting and compliance burdens on employers may make them less likely to offer CDBs to their employees and instead offer employees benefit coverage through state run health insurance exchanges. If employers are less incentivized to offer our CDB programs to employees because of increased regulatory burdens or otherwise, our results of operations and financial condition could be materially adversely affected.

 

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Failure to ensure and protect the confidentiality of participant data could lead to legal liability, adversely affect our reputation and have a material adverse effect on our results of operations, business or financial condition.

We must collect, store and use employee participants’ confidential information, including the transmission of that data to third parties, to provide our services. For example, we collect names, addresses, social security numbers and other personally identifiable information from employee participants. In addition, we facilitate the issuance and funding of prepaid debit cards and, in some cases, collect bank routing information, account numbers and personal credit card information for purposes of funding an account or issuing a reimbursement. We have invested significantly in preserving the security of this data.

We cannot assure you that, despite the implementation of these security measures, we will not be subject to a security breach or that this data will not be compromised. We may be required to expend significant capital and other resources to protect against security breaches or to alleviate problems caused by security breaches. Despite our implementation of security measures, techniques used to obtain unauthorized access or to sabotage systems change frequently. As a result, we may be unable to anticipate these techniques or implement adequate preventative measures to protect this data. Any compromise or perceived compromise of our security could damage our reputation with our clients and brokers, and could subject us to significant liability, as well as regulatory action, which would materially adversely affect our brand, results of operations, financial condition, business and prospects.

Privacy concerns could require us to modify our operations.

As part of our business, we collect employee participants’ personal data for the sole purpose of processing their benefits. For privacy or security reasons, privacy groups, governmental agencies and individuals may seek to restrict or prevent our use of this data. We have incurred, and will continue to incur, expenses to comply with privacy and security standards and protocols imposed by law, regulation, industry standards or contractual obligations. Increased domestic or international regulation of data utilization and distribution practices, including self-regulation, could require us to modify our operations and incur significant additional expense, which could have a material adverse effect on our results of operations, financial condition, business and prospects.

If we fail to effectively upgrade our information technology systems, our business and operations could be disrupted.

As part of our efforts to continue the improvement of our enterprise resource planning, we plan to upgrade our existing information technology systems in order to automate several controls that are currently performed manually. We may experience difficulties in transitioning to these upgraded systems, including loss of data and decreases in productivity as personnel work to become familiar with these new systems. In addition, our management information systems will require modification and refinement as we grow and as our business needs change, which could prolong difficulties we experience with systems transitions, and we may not always employ the most effective systems for our purposes. If we experience difficulties in implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems or respond to changes in our business needs, we may not be able to effectively manage our business and we may fail to meet our reporting obligations.

Our future success depends on our ability to recruit and retain qualified employees, including our executive officers.

Our success is substantially dependent upon the performance of our senior management, such as our chief executive officer. Our management and employees may terminate their employment at any time, and the loss of the services of any of our executive officers could materially adversely affect our business. Our success is also substantially dependent upon our ability to attract additional personnel for all areas of our organization.

Competition for qualified personnel is intense, and we may not be successful in attracting and retaining such

 

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personnel on a timely basis, on competitive terms or at all. If we are unable to attract and retain the necessary personnel, our results of operations, financial condition, business and prospects would be materially adversely affected.

We might require additional capital to support business growth in the future, and this capital might not be available on acceptable terms, if at all.

We believe that our existing cash and cash equivalents, combined with our credit line, expected cash flow from operations and net proceeds of this offering, will be sufficient to meet our operating and capital requirements, as well as anticipated requirements for potential additional portfolio purchases, for at least the next 12 months. Our business and operations may, however, consume resources faster than we currently anticipate. We intend to continue to make investments to support our business growth, including through additional portfolio purchases of complementary businesses, and may require additional funds in the future to respond to business challenges, including the need to develop new features and platforms, enhance our existing programs or improve our operating infrastructure. Accordingly, we may seek to sell additional equity or debt securities or obtain additional debt financing. 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 may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential portfolio purchases. We have not made arrangements to obtain additional financing and there can be no assurances that financing, if required, will be available in amounts or on terms acceptable to us, if at all.

Changes in credit card association or other network rules or standards set by Visa or MasterCard, or changes in card association and debit network fees or products or interchange rates, could materially adversely affect our results of operations, business and financial position.

We, and the banks that issue our prepaid debit cards, are subject to Visa and MasterCard association rules that could subject us to a variety of fines or penalties that may be levied by the card associations or networks for acts or omissions by us or businesses that work with us, including card processors, such as Fidelity National Information Services. The termination of the card association registrations held by us or any of the banks that issue our cards, or any changes in card association or other debit network rules or standards, including interpretation and implementation of existing rules or standards that increase the cost of doing business or limit our ability to provide our products and services, could have a material adverse effect on our results of operations, financial condition, business and prospects. In addition, from time-to-time, card associations increase the organization or processing fees that they charge, which could increase our operating expenses, reduce our profit margin and materially adversely affect our results of operations, financial condition, business and prospects.

Our operating results can fluctuate from period-to-period, which could cause our share price to fluctuate.

Our quarterly operating results may fluctuate as a result of a variety of factors, including fluctuations in our operating expenses during the year for items such as printing and temporary labor expenses. Fluctuations in our quarterly operating results could cause our stock price to decline rapidly, may lead analysts to change their long-term models for valuing our common stock, could cause short-term liquidity issues, may impact our ability to retain or attract key personnel or cause other unanticipated issues. If our quarterly operating results or guidance fall below the expectations of research analysts or investors, the price of our common stock could decline substantially.

Our quarterly operating expenses and operating results may vary significantly in the future and period-to-period comparisons of our operating results may not be meaningful. You should not rely on the results of one quarter as an indication of future performance.

 

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Our results of operations, financial condition, business and prospects could be materially adversely affected if we experience unanticipated delays in rollouts by our employer clients of services to their employee participants.

We generally do not earn fees from our employer clients until our services are available to their employee participants. If our infrastructure capacity is insufficient to meet our needs, we may experience delays in deploying our programs to new employer clients, or expanding the services we offer to existing employer clients, and on-boarding their employee participants. If the rollout of our services to our employer clients and, subsequently, their employee participants is delayed, our results of operations, financial condition, business and prospects could be materially adversely affected.

If we fail to manage future growth effectively, we may not be able to market and sell our products and services successfully.

We have expanded our operations significantly in recent years and anticipate that further expansion will be required in order for us to grow our business. If we do not effectively manage our growth, the quality of our services could suffer, which could materially adversely affect our results of operations, financial condition, business and prospects, and damage our reputation among existing and prospective clients. In order to manage our future growth, we will need to hire, integrate and retain highly skilled and motivated employees. We will also be required to continue to improve our existing systems for operational and financial information management, including our reporting systems, procedures and controls and regulatory compliance processes. These improvements may require significant capital expenditures and will place increasing demands on our management. We may not be successful in managing or expanding our operations, or in maintaining adequate operating and financial information systems and controls. If we are not successful in implementing improvements in these areas, our results of operations, financial condition, business and prospects would be materially adversely affected.

We have entered into outsourcing and other agreements with third parties related to certain of our business operations, and any difficulties experienced in these arrangements could result in additional expense, loss of revenue or an interruption of our services.

We have entered into outsourcing agreements with third parties to provide certain customer service and related support functions to our employer clients and their participant employees. As a result, we rely on third parties over which we have limited control to perform certain of our operations. If these third parties are unable to perform to our requirements or to provide the level of service required or expected by our employer clients and their employee participants, our operating results, financial condition, business, prospects and reputation may be materially harmed and we may be forced to pursue alternative strategies to provide these services, which could result in delays, interruptions, additional expenses and loss of clients and related revenues.

If our intellectual property and technology are not adequately protected to prevent use or appropriation by our competitors, our business and competitive position could be materially adversely affected.

We rely on a combination of copyright, trademark and trade secret laws, as well as confidentiality procedures and contractual provisions, to establish and protect our intellectual property rights in the United States.

The efforts we have taken to protect our intellectual property may not be sufficient or effective, and our trademarks and copyrights may be held invalid or unenforceable. We may not be effective in policing unauthorized use of our intellectual property, and even if we do detect violations, litigation may be necessary to enforce our intellectual property rights. Any enforcement efforts we undertake, including litigation, could be time consuming and expensive, could divert our management’s attention and may result in a court determining that our intellectual property rights are unenforceable. If we are not successful in cost-effectively protecting our intellectual property rights, our results of operations, financial condition, business and prospects could be materially adversely affected.

 

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Our ability to use net operating loss carryforwards to offset future taxable income may be limited.

As of December 31, 2011, we had $47.9 million of federal and $38.9 million of state net operating loss carryforwards available to offset future taxable income. These net operating loss carryforwards will expire beginning in 2023 through 2029 for U.S. federal income tax purposes and beginning in 2012 through 2031 for state income tax purposes, if not fully utilized. In addition, we have federal and state research and development credit carryforwards of $2.6 million and $1.1 million respectively. The federal research credit carryforwards expire beginning in the years 2022 through 2031, if not fully utilized. The California research credit carries forward indefinitely. Our ability to utilize net operating loss and tax credit carryforwards in the future may be subject to substantial restriction under applicable law, including in the event of past or future ownership changes as defined in Section 382 of the Internal Revenue Code of 1986, as amended and similar state law (including in connection with this offering), which ownership changes may be outside of our control.

If one or more jurisdictions successfully assert that we should have collected or in the future should collect additional sales and use taxes on our fees, we could be subject to additional liability with respect to past or future sales and the results of our operations could be adversely affected.

We do not collect sales and use taxes in all jurisdictions in which our employer clients are located, based on our belief that such taxes are not applicable. Sales and use tax laws and rates vary by jurisdiction and such laws are subject to interpretation. Jurisdictions in which we do not collect sales and use taxes may assert that such taxes are applicable, which could result in the assessment of such taxes, interest and penalties, and we could be required to collect such taxes in the future. This additional sales and use tax liability could adversely affect the results of our operations.

Third parties may assert intellectual property infringement claims against us, or our services may infringe the intellectual property rights of third parties, which may subject us to legal liability and materially adversely affect our reputation.

Assertion of intellectual property infringement claims against us could result in litigation. We might not prevail in any such litigation or be able to obtain a license for the use of any infringed intellectual property from a third party on commercially reasonable terms, or at all. Even if obtained, we may be unable to protect such licenses from infringement or misuse, or prevent infringement claims against us in connection with our licensing efforts. Any such claims, regardless of their merit or ultimate outcome, could result in substantial cost to us, divert management’s attention and our resources away from our operations and otherwise adversely affect our reputation. Our process for controlling our own employees’ use of third-party proprietary information may not be sufficient to prevent assertions of intellectual property infringement claims against us.

We rely on insurance to mitigate some risks of our business and, to the extent the cost of insurance increases or we maintain insufficient coverage, our results of operations, business and financial condition may be materially adversely affected.

We contract for insurance to cover a portion of our potential business risks and liabilities. In the current environment, insurance companies are increasingly specific about what they will and will not insure. It is possible that we may not be able to obtain sufficient insurance to meet our needs, may have to pay very high prices for the coverage we do obtain or may not acquire any insurance for certain types of business risk. This could leave us exposed, and to the extent we incur liabilities and expenses for which we are not adequately insured, our results of operations, business and financial condition could be materially adversely affected. Also, to the extent the cost of maintaining insurance increases, our operating expenses will rise, which could materially adversely affect our results of operations, financial condition, business and prospects.

 

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Risks Related to this Offering and Ownership of Our Common Stock

VantagePoint Capital Partners will continue to hold a high percentage of our common stock following the completion of this offering, which may limit the ability of our public stockholders to affect significant corporate actions.

After this offering, funds affiliated with VantagePoint Capital Partners, or VantagePoint, will own approximately         % of our outstanding common stock, assuming no exercise by the underwriters of their overallotment option. In addition, we and VantagePoint intend to enter into a stockholder agreement related to a number of board of directors, stockholder and related governance matters.

Furthermore, such stockholder agreement will also provide that the following actions by us require the approval of VantagePoint for so long as VantagePoint owns 25% or more of our outstanding shares of common stock:

 

   

any amendment of our bylaws;

 

   

the issuance of any securities with economic rights senior to our common stock or with voting rights different than our common stock, subject to certain exceptions;

 

   

the incurrence or guarantee of any debt in excess of $20.0 million;

 

   

the issuance of equity or debt, or any securities convertible into equity or debt, for consideration in excess of 12.5% of our market capitalization;

 

   

the acquisition or disposition of stock or assets, including through a license or lease, for consideration in excess of 12.5% of our market capitalization;

 

   

the adoption of a stockholder rights plan;

 

   

the approval of any “golden parachute” or other compensatory plan contingent upon a change in control of us for any of our executive officers valued in excess of $1 million for an individual officer or $5 million for a group of officers, at the time such compensatory arrangement is adopted; or

 

   

any change in the number of authorized directors.

Accordingly, our ability to engage in significant transactions, such as a merger, acquisition or liquidation, is limited without the consent of VantagePoint. Conflicts of interest could arise between us and VantagePoint, and any conflict of interest may be resolved in a manner that does not favor us. VantagePoint may decide not to consent to a transaction in which you would receive consideration for your common shares that is higher than the cost to you or the then-current market price of those shares. Any decision that VantagePoint may make at some future time regarding their ownership of us will be in their absolute discretion.

In addition, our stockholder agreement with VantagePoint and our certificate of incorporation and bylaws to be in effect upon the completion of this offering will provide the following additional rights to VantagePoint:

 

   

so long as VantagePoint owns more than 30% of our outstanding voting stock, a special meeting of our stockholders may be called by either VantagePoint or any two members of our board of directors, whether or not VantagePoint designees;

 

   

so long as VantagePoint owns more than 40% of our outstanding voting stock, our stockholders may act by written consent to change the number of authorized directors, remove a director without cause or fill a vacancy on our board of directors;

 

   

we may not amend any provision of our certificate of incorporation or bylaws relating to VantagePoint’s rights without VantagePoint’s consent; and

 

   

VantagePoint and its representatives will have access to our books and records, subject to customary confidentiality and non-disclosure provisions.

 

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VantagePoint will have the right to designate (and remove or replace) three of the members of our board of directors if VantagePoint owns at least 50% or more of our outstanding shares, two members of our board of directors if VantagePoint owns between 20% and 50% of our outstanding shares, and one member of our board of directors if VantagePoint owns between 10% and 20% of our outstanding shares. VantagePoint shall also have the right to select one of its board designees to serve on our compensation committee, our nominating and corporate governance committee and any other special committee of our board of directors, so long as it continues to hold at least 10% of our outstanding shares.

VantagePoint is not prohibited from selling its interest in us to a third party.

We will incur increased costs and demands upon management as a result of complying with the laws and regulations that affect public companies, which could materially adversely affect our results of operations, financial condition, business and prospects.

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting and corporate governance requirements. These requirements include compliance with Section 404 and other provisions of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as rules implemented by the SEC and the NYSE. In addition, our management team will also have to adapt to the requirements of being a public company. We expect that compliance with these rules and regulations will substantially increase our legal and financial compliance costs and will make some activities more time-consuming and costly.

The increased costs associated with operating as a public company will decrease our net income or increase our net loss, and may require us to reduce costs in other areas of our business or increase the prices of our products or services. Additionally, if these requirements divert our management’s attention from other business concerns, they could have a material adverse effect on our results of operations, financial condition, business and prospects.

As a public company, we also expect that it may be more difficult and expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as our executive officers.

As a public company, we will be required to maintain a system of effective control over financial reporting. It was determined in connection with the audit of our 2010 financial results that we had significant deficiencies with respect to instances of lack of timely financial reporting and reliable financial statements, inability to timely integrate the accounting function of certain of our portfolio purchases and inconsistencies and omissions in key documents and that in connection with the audit of our 2011 financial results that we still had a significant deficiency regarding our inability to timely integrate the accounting function of certain of our portfolio purchases. If we do not remediate this significant deficiency and develop effective controls, our impaired ability to produce accurate and timely financial reports could cause our stock price to decline.

We have, in the past, experienced issues with our internal control over financial reporting. For example, three significant deficiencies were identified in internal controls in connection with the preparation of our financial statements and the audit of our financial results for 2010. We had significant deficiencies relating to: the completion of our financial reporting cycle within the expected period and our ability to produce reliable financial statements in the period that would normally be expected of a public company; our ability to timely integrate accounting functions of certain of our portfolio purchases; and certain inconsistencies and omissions in some of our key documents and agreements. The lack of timely financial reporting involved adjustments of a bonus accrual that was not timely made and the number of errors, missing disclosures and incorrect numbers in the financial statements we delivered to our independent registered public accounts for audit. The inability to timely integrate the accounting function of portfolio purchases related to our inability through March 2011 to

 

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reconcile an opening balance sheet for our PBS acquisition on August 31, 2010. The inconsistencies and omissions in key documents related to certain agreements that were not appropriately documented or referred to other agreements that did not exist, including agreements relating to our acquisition of the CDB assets of FBM.

In connection with the preparation of our financial statements and the audit of our financial results for 2011, it was determined that we remediated the significant deficiency relating to lack of timely financial reporting and reliable financial statements by the hiring of additional qualified accounting personnel. Hires to date include an SEC reporting director, an internal auditor who will also address Sarbanes-Oxley issues, an accounting manager, a general ledger accountant, a financial analyst and a treasury analyst. It was also determined that we remediated the significant deficiency related to inconsistencies and omissions in some of our key documents and agreements. Since we did not complete any portfolio purchases in 2011, we were unable to remediate the significant deficiency with respect to timely integration of the accounting function of portfolio purchases. However, we intend to do so by earlier assessment of the accounting function at the company from which the portfolio is purchased and allocation of needed resources, including the hiring of consultants, to assure timely integration. For example, for the acquisition and portfolio purchase that we have completed in 2012, we have assigned a full-time accounting resource and a consultant to lead the accounting integration of CS and TC.

We cannot assure that these actions will entirely remediate this significant deficiency or that other material weaknesses or significant deficiencies will not be discovered.

After this offering, we will become subject to certain reporting and corporate governance requirements, including the rules and regulations of the SEC, the Public Company Accounting Oversight Board and the listing standards of the New York Stock Exchange, and the provisions of the Sarbanes-Oxley Act, and the regulations promulgated thereunder, which will impose significant new compliance obligations upon us. As a public company, we will be required, among other things, to evaluate and maintain our system of internal control over financial reporting, and report on management’s assessment thereof, in compliance with the requirements of Section 404 of the Sarbanes-Oxley Act and related rules and regulations of the SEC and the Public Company Accounting Oversight Board.

We are in the very early stages of the costly and challenging process of compiling the system and processing documentation necessary to perform the evaluation needed to comply with Section 404. We may not be able to complete our evaluation, testing and implementation of any required remediation in a timely fashion. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are effective. If we are unable to assert that our internal control over financial reporting is effective, or if our auditors are unable to express an unqualified opinion on the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which would have a material adverse effect on the price of our common stock.

An active trading market for our common stock may not develop as a result of this offering, in part due to the small public float.

Prior to this offering, there has been no public market for shares of our common stock. The initial public offering price of our common stock will be determined through negotiation with the underwriters. This price will not necessarily reflect the price at which investors in the market will be willing to buy and sell our shares of common stock following this offering. In addition, 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.

In addition, the stock market in general, and the market for newly public companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may seriously affect the market

 

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price of companies’ stock, including ours, regardless of actual operating performance. These fluctuations may be even more pronounced in the trading market for our stock shortly following this offering. In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against such a company. If securities class action litigation is instituted against us, it could result in substantial costs and a diversion of our management’s attention and resources and could materially adversely affect our operating results.

A total of              shares, or     %, of our total outstanding shares after the offering are restricted from immediate resale, but may be sold on the NYSE in the near future. The large number of shares eligible for public sale or subject to rights requiring us to register them for public sale could depress the market price of our common stock.

The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market after this offering, and the perception that these sales could occur may also depress the market price of our common stock. Based on shares outstanding as of December 31, 2011, we will have              shares of common stock outstanding after this offering. Of these shares, the common stock sold in this offering will be freely tradable in the United States, except for any shares purchased by our “affiliates” as defined in Rule 144 under the Securities Act of 1933, as amended. The holders of              shares of outstanding common stock have agreed with us or the underwriters, subject to certain exceptions, not to dispose of or hedge any of their common stock during the 180-day period beginning on the date of this prospectus, except with the prior written consent of Credit Suisse Securities (USA) LLC. After the expiration of the 180-day restricted period, these shares may be sold in the public market in the United States, subject to prior registration in the United States, if required, or reliance upon an exemption from U.S. registration, including, in the case of shares held by affiliates or control persons, compliance with the volume restrictions of Rule 144.

 

Number of Shares

and % of Total

Outstanding

  

Date Available for Sale into Public Markets

             or     %

   Immediately after this offering.

             or     %

   180 days after the date of this prospectus due to contractual obligations and lock-up agreements between the holders of these shares and us or the underwriters. However, the underwriters may waive the provisions of these lock-up agreements and allow these stockholders to sell their shares at any time, provided their respective one-year holding periods under Rule 144 have expired.

             or     %

   From time-to-time after the date 180 days after the date of this prospectus and upon expiration of stockholders’ respective one-year holding periods in the United States.

Upon completion of this offering, stockholders owning an aggregate of              shares (including 17,687,612 shares issuable upon conversion of our preferred stock) will be entitled, under agreements providing for registration rights, to require us to register shares of our common stock owned by them for public sale in the United States. In addition, we intend to file a registration statement to register the approximately              shares reserved for future issuance under our equity compensation plans. Upon the effectiveness of that registration statement, subject to the satisfaction of applicable exercise periods and, in certain cases, lock-up agreements with the representatives of the underwriters referred to above, the shares of common stock issued upon exercise of outstanding options will be available for immediate resale in the United States in the open market.

Sales of our common stock, as restrictions end or pursuant to registration rights, may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. These sales also could cause our stock price to fall and make it more difficult for you to sell shares of our common stock.

 

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Anti-takeover provisions contained in our certificate of incorporation and bylaws, as well as provisions of Delaware law, could impair a takeover attempt.

Our certificate of incorporation, bylaws and Delaware law contain provisions that could have the effect of delaying, preventing or rendering more difficult an acquisition of us if such acquisition is deemed undesirable by our board of directors. Our corporate governance documents include provisions that:

 

   

create a classified board of directors whose members serve staggered three-year terms;

 

   

authorize “blank check” preferred stock, which could be issued by the board of directors without stockholder approval and may contain voting, liquidation, dividend and other rights superior to our common stock;

 

   

limit the ability of our stockholders to call and bring business before special meetings;

 

   

limit the ability of stockholders to act by written consent to such periods during which VantagePoint Capital Partners and its affiliates hold 40% or more of our outstanding common stock;

 

   

require advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors;

 

   

control the procedures for the conduct and scheduling of board of directors and stockholder meetings; and

 

   

provide the board of directors with the express power to postpone previously scheduled annual meetings and to cancel previously scheduled special meetings.

These provisions, alone or together, could delay or prevent unsolicited takeovers and changes in control or changes in our management.

As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation law, which prevents some stockholders holding more than 15% of our outstanding common stock from engaging in certain business combinations without approval of the holders of substantially all of our outstanding common stock.

Any provision of our certificate of incorporation or bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock and could also affect the price that some investors are willing to pay for our common stock.

Purchasers in this offering will experience immediate and substantial dilution in the book value of their investment.

The anticipated initial public offering price of our common stock is substantially higher than the net tangible book value per share of our outstanding common stock immediately after this offering. Therefore, if you purchase our common stock in this offering, you will incur immediate dilution of $             in net tangible book value per share from the price you paid. In addition, following this offering, purchasers in this offering will have contributed     % of the total consideration paid by our stockholders to purchase shares of common stock, in exchange for acquiring approximately     % of our total outstanding shares as of December 31, 2011 after giving effect to this offering. The exercise of outstanding stock options and warrants will result in further dilution.

If securities or industry analysts do not publish or cease publishing research or reports about us, our business or our market, or if they change their recommendations regarding our stock adversely, our stock price and trading volume could decline.

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If any of the analysts who

 

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may cover us change their recommendation regarding our stock adversely, or provide more favorable relative recommendations about our competitors, our stock price would likely decline. If any analyst who may cover us were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that increase the value of your investment.

Our management will have broad discretion in the application of the net proceeds of this offering. We cannot specify with certainty the uses to which we will apply these net proceeds. The failure by our management to apply these funds effectively could adversely affect our ability to continue to maintain and expand our business and adversely affect the price of our common stock.

After the completion of this offering, we do not expect to declare any dividends in the foreseeable future.

After the completion of this offering, we do not anticipate declaring any cash dividends to holders of our common stock in the foreseeable future. In addition, our existing credit facility prohibits us from paying cash dividends, and any future financing agreements may prohibit us from paying any type of dividends. Consequently, investors may need to rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends should not purchase our common stock.

 

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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

This prospectus includes forward-looking statements that relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Words such as, but not limited to, “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “targets,” “likely,” “will,” “would,” “could,” and similar expressions or phrases, or the negative of those expressions or phrases, identify forward-looking statements.

Although we believe that we have a reasonable basis for each forward-looking statement contained in this prospectus, we caution you that these statements are based on our projections of the future that are subject to known and unknown risks and uncertainties and other factors that may cause our actual results, level of activity, performance or achievements expressed or implied by these forward-looking statements, to differ. The sections in this prospectus entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” as well as other sections in this prospectus, discuss some of the factors that could contribute to these differences.

Other unknown or unpredictable factors could also harm our results. Consequently, actual results or developments anticipated by us may not be realized or, even if substantially realized, may not have the expected consequences to, or effects on, us. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. Except as required by law, we undertake no obligation to update or revise publicly any of the forward-looking statements after the date of this prospectus.

You may rely only on the information contained in this prospectus. Neither we nor any of the underwriters have authorized anyone to provide information different from that contained in this prospectus. Neither the delivery of this prospectus, nor sale of common stock, means that information contained in this prospectus is correct after the date of this prospectus. This prospectus is not an offer to sell or solicitation of an offer to buy shares of common stock in any circumstances under which the offer or solicitation is unlawful.

MARKET, INDUSTRY AND OTHER DATA

Unless otherwise indicated, information contained in this prospectus concerning our industry and the markets 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 services. These data involve a number of assumptions and limitations. We have not independently verified the accuracy of any third party information. In addition, projections, assumptions and estimates of our future performance and the future performance of the industry in which we operate is 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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USE OF PROCEEDS

We estimate that our net proceeds from the sale of shares of our common stock in this offering will be approximately $             million, assuming an initial public offering price of $             per share, which is the midpoint of the price range reflected on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses that we must pay in connection with this offering. Each $1.00 increase or decrease in the assumed initial public offering price of $             per share, which is the midpoint of the price range reflected on the cover page of this prospectus, would increase or decrease, as applicable, our cash and cash equivalents, working capital, total assets and total stockholders’ equity (deficit) 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 the estimated underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters’ overallotment option to purchase additional shares from us is exercised in full, we estimate that we will receive additional net proceeds of $             million.

The principal purposes of this offering are to obtain additional capital, to create a public market for our common stock and to facilitate our future access to the public equity markets.

We cannot specify with certainty the particular uses for the net proceeds to be received by us from this offering. Accordingly, our management team will have broad discretion in using the net proceeds to be received by us from this offering. We currently intend to use the net proceeds received by us from this offering for working capital, including funding of customer obligations, and general corporate purposes, including further expansion of our sales and marketing efforts, continued investments in technology and development and for capital expenditures. Specifically, we intend to hire additional personnel to support the growth in our business. In addition, we may use a portion of the proceeds received by us from this offering for portfolio purchases of complementary businesses, technologies or assets to expand our employer client base. We have no agreements with respect to any portfolio purchases at this time.

Pending such uses, we plan to invest the net proceeds in short- and intermediate-term, interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government.

 

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DIVIDEND POLICY

We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors and will be dependent on a number of factors, including our earnings, capital requirements and overall financial conditions. Currently, our credit facility with Union Bank, N.A. prohibits our payment of any dividends without obtaining its prior written consent, other than dividends payable solely in our common stock.

 

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CAPITALIZATION

The table below sets forth our cash and cash equivalents and capitalization as of December 31, 2011 on:

 

   

an actual basis;

 

   

an unaudited pro forma basis, after giving effect, upon the completion of this offering and the filing of our amended and restated certificate of incorporation, to (i) the conversion of all of our outstanding shares of preferred stock into a fixed aggregate of 17,687,612 shares of our common stock, (ii) the conversion of our outstanding Series C preferred stock warrants into warrants to purchase a fixed 211,764 shares of our common stock, and (iii) the conversion of our outstanding Series E-1 preferred stock warrants into warrants to purchase a fixed 4,366,803 shares of our common stock; and

 

   

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

You should read this table together with our consolidated financial statements and the related notes thereto, as well as the information under “Management’s Discussion and Analysis of Financial Conditions and Results of Operations.” The unaudited “pro forma” and “pro forma as adjusted” information below is prepared for illustrative purposes only and our capitalization following the completion of this offering will be adjusted based on the actual initial public offering price and other terms of the offering determined at pricing.

The following table reflects a 1-for-2 reverse stock split of our outstanding common stock effected on July 15, 2011.

 

    As of December 31, 2011
    Actual     Pro Forma     Pro Forma As
Adjusted
   

 

    (unaudited)     (unaudited)
    (in thousands, except share and per share
data)

Cash and cash equivalents

  $ 154,621      $ 154,621     
 

 

 

   

 

 

   

 

Bank borrowings

  $ 14,901      $ 14,901     
 

 

 

   

 

 

   

 

Warrants

  $ 1,119       
 

 

 

     

Total redeemable convertible preferred stock

  $ 82,169       
 

 

 

     

Stockholder’s equity (deficit):

     

Convertible preferred stock, Series A, $0.001 par value ($200 liquidation preference); authorized 50,000 shares; issued and outstanding 50,000 shares, actual; no shares issued or outstanding, pro forma; no shares issued or outstanding, pro forma as adjusted

    200       

Convertible preferred stock, Series A-1, $0.001 par value ($6,903 liquidation preference); authorized 1,725,792 shares; issued and outstanding 1,725,792 shares, actual; no shares issued or outstanding, pro forma; no shares issued or outstanding, pro forma as adjusted

    6,903       

Convertible preferred stock, Series A-2, $0.001 par value ($3,995 liquidation preference); authorized 1,013,383 shares; issued and outstanding 998,661 shares, actual; no shares issued or outstanding, pro forma; no shares issued or outstanding, pro forma as adjusted

    3,995       

Convertible preferred stock, Series B, $0.001 par value ($20,818 liquidation preference); authorized 14,870,179 shares; issued and outstanding 14,870,179 shares, actual; no shares issued or outstanding, pro forma; no shares issued or outstanding, pro forma as adjusted

    22,867       

Common stock, $0.001 par value; authorized 60,528,131 shares; issued 1,737,721 shares, actual; authorized 1,000,000,000 shares, pro forma and pro forma as adjusted; issued, 19,425,333 shares pro forma; issued              shares, pro forma as adjusted

    2        19     

Treasury stock

    (433     (433  

Additional paid-in capital

    19,029        136,265     

Accumulated deficit

    (74,620     (74,620  
 

 

 

   

 

 

   

 

Total stockholders’ equity (deficit)

    (22,057     61,231     
 

 

 

   

 

 

   

 

Total capitalization

  $ 76,132      $ 76,132     
 

 

 

   

 

 

   

 

 

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If the underwriters exercise their option to purchase additional shares of common stock in full, assuming the number of shares offered by us under this prospectus remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, net proceeds to us would increase by approximately $             million.

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) each of our unaudited pro forma as adjusted cash and cash equivalents, additional paid-in capital, total stockholders’ (deficit) equity and total capitalization by approximately $             million, or by approximately $             million if the underwriters exercise their option to purchase additional shares of common stock in full, assuming the number of shares offered by us under this prospectus remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

The outstanding share information in the capitalization table above is based on the number of shares outstanding as of December 31, 2011, and excludes:

 

   

4,539,860 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2011, at a weighted average exercise price of $7.29 per share;

 

   

75,000 shares of common stock issuable upon the exercise of a warrant outstanding as of December 31, 2011 to purchase common stock, at an exercise price of $8.20 per share;

 

   

4,578,567 shares of common stock, on an as-converted basis and assuming the conversion occurs immediately prior to the completion of this offering, issuable upon the exercise of warrants outstanding as of December 31, 2011 to purchase convertible preferred stock, at a weighted average exercise price of $4.76 per share; and

 

   

474,940 shares of common stock reserved for future issuance under our 2010 Equity Incentive Plan as of December 31, 2011.

 

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DILUTION

Our pro forma net tangible book value as of December 31, 2011 was $             million, or $             per share of common stock. The only difference between the pre-offering as reported net tangible book value and the pre-offering pro forma net tangible book value relates to the reclassification of our outstanding Series C preferred stock warrants from liability to equity and the conversion of our outstanding preferred stock that was not previously classified as equity. The amount of this difference is a decrease of $             per share. Pro forma net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the pro forma number of shares of common stock outstanding, after giving effect upon the completion of this offering and the filing of our amended and restated certificate of incorporation, to (i) the conversion of all of our outstanding shares of preferred stock into a fixed aggregate of 17,687,612 shares of our common stock, (ii) the conversion of our outstanding Series C preferred stock warrants into warrants to purchase a fixed 211,764 shares of our common stock, and (iii) the conversion of our outstanding Series E-1 preferred stock warrants into warrants to purchase a fixed 4,366,803 shares of our common stock. Net tangible book value dilution per share represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the pro forma net tangible book value per share of common stock immediately after completion of this offering on a pro forma as adjusted basis. The only anticipated difference between the pre- and post-net tangible book value are the net proceeds of the offering. After giving effect to the sale of the              shares of common stock by us at an assumed initial public offering price of $             per share, which is the midpoint of the price range set forth on the cover of this prospectus, and the application of our estimated net proceeds from the offering, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our net tangible book value as of December 31, 2011 would have been $             million, or $             per share of common stock. This estimate represents an immediate increase in net tangible book value of $             per share of common stock to existing common stockholders and an immediate dilution in net tangible book value of $             per share to new investors purchasing shares of common stock in this offering. The following table illustrates this per share dilution after giving effect to the 1-for-2 reverse stock split of our outstanding common stock effected on July 15, 2011:

 

Assumed initial public offering price per share

  
  

 

Historical net tangible book value per share as of December 31, 2011

  

Pro forma increase in net tangible book value per share as of December 31, 2011 attributable to reclassification of Series C preferred stock warrants from liability to equity

  

Pro forma decrease in net tangible book value per share as of December 31, 2011 attributable to preferred stock conversion

  
  

 

Pro forma net tangible book value per share before this offering

  

Increase in pro forma net tangible book value per share attributable to new investors

  

Pro forma net tangible book value per share after this offering

  
  

 

Dilution in pro forma net tangible book value per share to new investors

  
  

 

A $1.00 increase in the assumed initial public offering price of $             per share would increase our pro forma as adjusted net tangible book value after this offering by approximately $             million, and the pro forma as adjusted net tangible book value per share after this offering would be $             per share. A $1.00 decrease in the assumed initial public offering price of $             per share would decrease our pro forma as adjusted net tangible book value after the offering by approximately $             million and the pro forma as adjusted net tangible book value per share after this offering would be $             per share. It would also increase (decrease) the dilution per share to new investors in this offering by $             per share, assuming the number of shares offered by us under this prospectus remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. The information discussed above is illustrative only and will adjust based on the actual initial public offering price and other terms of the offering determined at pricing.

 

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The following table summarizes as of December 31, 2011, on the pro forma basis described above, the number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid by existing stockholders before this offering and investors participating in this offering paid, before deducting the estimated underwriting discounts and commissions and estimated offering expenses. In addition, the table includes the shares underlying stock options, preferred stock warrants and common stock warrants that officers, directors and other affiliates have the right to acquire.

 

     Shares Purchased     Total Consideration     Average Price
per Share
 
         Number            Percent             Amount              Percent        
                (in thousands)               

Existing Stockholders

               $                             $                

Options and warrants held by affiliates

            

New Investors (shares sold by us)

            
  

 

  

 

 

   

 

 

    

 

 

   
               $                 
  

 

  

 

 

   

 

 

    

 

 

   

The table above is based on the number of shares outstanding as of December 31, 2011, and excludes:

 

   

2,405,569 shares of common stock issuable upon the exercise of options outstanding to non-affiliates as of December 31, 2011, at a weighted average exercise price of $7.35 per share;

 

   

75,000 shares of common stock issuable upon the exercise of a warrant outstanding as of December 31, 2011 to purchase common stock, at an exercise price of $8.20 per share;

 

   

211,764 shares of common stock, on an as-converted basis assuming the conversion immediately prior to the completion of this offering, issuable upon the exercise of a warrant outstanding as of December 31, 2011 to purchase convertible preferred stock, at an exercise price of $8.50 per share; and

 

   

474,940 shares of common stock reserved for future issuance under our 2010 Equity Incentive Plan as of December 31, 2011.

To the extent that any outstanding options are exercised, there will be further dilution to new investors.

 

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SELECTED CONSOLIDATED FINANCIAL INFORMATION

The following selected consolidated financial data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes included elsewhere in this prospectus. The selected consolidated balance sheet data as of December 31, 2010 and 2011, and the selected consolidated statements of operations data for each of 2009, 2010 and 2011 have been derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. The selected consolidated balance sheet data as of December 31, 2007, 2008 and 2009 and the selected consolidated statements of operations data for each of 2007 and 2008 have been derived from our audited consolidated financial statements not included in this prospectus. The following selected consolidated financial information reflects the 1-for-2 reverse stock split of our outstanding common stock effected on July 15, 2011. Historical results are not necessarily indicative of the results to be expected in the future.

 

    Year Ended December 31,  
    2007     2008     2009     2010     2011  
    (in thousands, except per share data)  

Consolidated Statement of Operations Data:

         

Revenues

  $ 89,765      $ 103,273      $ 108,461      $ 115,047      $ 135,637   

Operating expenses:

         

Cost of revenues (excluding amortization of internal use software)

    48,459        49,298        46,802        50,205        55,651   

Sales and marketing, technology and development and general and administration

    36,115        49,552        52,792        49,044        55,099   

Amortization and change in contingent consideration

    6,867        7,987        8,398        7,764        11,327   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expense

    91,441        106,837        107,992        107,013        122,077   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    (1,676     (3,564     469        8,034        13,560   

Other income (expense):

         

Interest income

    1,403        1,368        851        220        36   

Interest expense

    (2,189     (1,570     (1,102     (188     (494

Interest expense—amortization of convertible debt

    —          —          (71     (21,107     —     

Other, net

    (643     (72     (286     (5,413     351   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (3,105     (3,838     (139     (18,454     13,453   

Income tax (provision) benefit

    (315     (487     (495     1,204        19,868   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (3,420     (4,325     (634     (17,250     33,321   

Accretion of redemption premium (expense) benefit

    (3,837     (3,130     1,037        (6,740     (6,209
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common stockholders

  $ (7,257   $ (7,455   $ 403      $ (23,990   $ 27,112   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share attributable to common stockholders:

         

Basic

  $ (4.82   $ (4.45   $ 0.25      $ (15.70   $ 17.65   

Diluted

  $ (4.82   $ (4.45   $ (0.04   $ (15.70   $ 1.43   

Share outstanding

         

Basic

    1,505        1,674        1,606        1,528        1,536   

Diluted

    1,505        1,674        16,864        1,528        20,086   

 

Pro forma net income per share attributable to common stockholders (unaudited):

 

Basic(1)

  $ 1.72   

Diluted(1)

  $ 1.45   

Pro forma weighted average shares outstanding used in computing net income per share attributable to common stockholders (unaudited):

 

Basic(1)

    19,224   

Diluted(1)

    22,734   

 

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    At December 31,  
    2007     2008     2009     2010     2011  
    (in thousands)  
                               

Consolidated Balance Sheet Data:

         

Cash and cash equivalents

  $ 49,978      $ 72,102      $ 93,261      $ 104,280      $ 154,621   

Total current assets

    72,657        90,704        108,515        124,337        179,829   

Total assets

    138,144        159,615        171,478        206,831        278,696   

Total current liabilities

    120,763        145,004        153,303        167,648        215,645   

Total liabilities

    143,869        167,892        167,430        182,254        218,584   

Total redeemable convertible preferred stock

    45,950        49,080        48,043        75,960        82,169   

Total stockholder’s deficit

    (51,675     (57,357     (43,995     (51,383     (22,057

 

    Year Ended December 31,  
    2007     2008     2009     2010     2011  
    (in thousands)  

Non-GAAP Financial Data:

         

Adjusted EBITDA(2) (unaudited)

  $ 8,867      $ 10,752      $ 15,941      $ 22,366      $ 30,330   

 

(1)   See Note 2 to our consolidated financial statements for an explanation of the method used to calculate the unaudited pro forma basic and diluted net income per share. All shares to be issued in the offering were excluded from the unaudited pro forma basic and diluted net income (loss) per share calculation.
(2)   We define Adjusted EBITDA as net income (loss), calculated in accordance with GAAP, plus: (i) depreciation; (ii) amortization and change in contingent consideration; (iii) stock-based compensation expense; (iv) interest expense (income), net; (v) income tax (benefit) provision; (vi) interest expense: amortization of convertible debt discounts; (vii) loss (gain) on revaluation of warrants; and (viii) loss on extinguishment of debt.

Adjusted EBITDA is not a recognized presentation in accordance with GAAP. An explanation of the elements of Adjusted EBITDA, a full reconciliation of net income (loss), which is the most directly comparable GAAP measure to Adjusted EBITDA, and the material limitations of Adjusted EBITDA are set forth below. Adjusted EBITDA should not be considered as an alternative to net income, income from operations or any other measure of financial performance calculated and presented in accordance with GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of other companies because other companies may not calculate Adjusted EBITDA or similarly titled measures in the same manner that we do. We prepare Adjusted EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. We encourage you to evaluate these adjustments and the reasons we consider them appropriate.

Our management uses Adjusted EBITDA:

 

   

as a measure of operating performance;

 

   

as a factor when determining management’s compensation;

 

   

for planning purposes, including the preparation of our annual operating budget;

 

   

to allocate resources of our business; and

 

   

to evaluate the effectiveness of our business strategies.

We believe that the use of Adjusted EBITDA as an operational performance metric provides greater consistency and comparability with our past financial performance and facilitates period-to-period comparisons of our operating results by management and investors. Although calculation of Adjusted EBITDA may vary from company-to-company, our presentation of Adjusted EBITDA may facilitate analysis and comparison of our operating results by management and investors with other peer companies that may use similar non-GAAP financial measures to supplement their GAAP results in their public disclosures. While we believe Adjusted EBITDA is a useful measure for our management and investors in evaluating our operating performance and business trends, there are material limitations to the use of Adjusted EBITDA. For a further discussion of these limitations, see below in this footnote.

We believe that it is useful to exclude non-cash charges for depreciation, amortization and change in contingent consideration, amortization of convertible debt discounts, loss (gain) on revaluation of warrants, losses associated with the extinguishment of debt and stock-based compensation from Adjusted EBITDA because (i) the amount of such non-cash expenses in any specific period may not directly correlate to the underlying operational performance of our business and (ii) such expenses can vary significantly between periods as a result of new acquisitions, full amortization of previously acquired intangible assets, full amortization of convertible debt discounts or the timing of new stock-based awards.

 

   

Depreciation, amortization and change in contingent consideration. We believe that it is useful to exclude depreciation, amortization and change in contingent consideration from Adjusted EBITDA because depreciation is a function of our capital expenditures, while

 

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amortization and change in contingent consideration reflect other asset acquisitions and their associated costs made at a prior point or points in time. In analyzing the performance of our business currently, management believes it is helpful to also consider the business without taking into account costs or benefits accruing from historical decisions on infrastructure and capacity. While these expense and related investments affect the overall financial health of our company, they are separately evaluated and relate to historic decisions. Further, depreciation and amortization do not result in ongoing cash expenditures. Investors should note that the use of assets being depreciated or amortized contributed to revenues earned during the periods presented and will continue to contribute to future period revenues. This depreciation and amortization expense will recur in future periods for GAAP purposes.

 

   

Losses (gains) associated with the revaluation of warrants. We believe that it is useful to exclude losses (gains) associated with the revaluation of warrants from Adjusted EBITDA. These items vary significantly in size and amount and are excluded by our management when evaluating and predicting earnings trends because these charges are based on many subjective inputs at a point in time and many of these inputs are not necessarily directly related to the performance of our business. Due to subjective assumptions that underlie valuation methodologies used in the calculation, as well as the impact of non-operational factors such as our share price, on the magnitude of this expense, management excludes these gains or losses when evaluating the ongoing performance of our business.

 

   

Losses associated with the extinguishment of debt and amortization of convertible debt discount. We believe that it is useful to exclude losses associated with the extinguishment of debt and amortization of convertible debt discount from Adjusted EBITDA. These items vary significantly in size and amount and are excluded by our management when evaluating and predicting earnings trends because these charges are unique to specific financings. We, therefore, exclude these cash and non-cash charges when presenting Adjusted EBITDA.

 

   

Stock-based compensation expense. We believe that it is useful in evaluating our financial performance to exclude stock-based compensation expense from Adjusted EBITDA because non-cash equity grants made at various points in time based on the value of our stock do not necessarily reflect how our business is performing at any particular time. While we believe that investors should have information about any dilutive effect of outstanding options and the cost of that compensation, we also believe that investors should have the ability to view Adjusted EBITDA as a non-GAAP financial measure that excludes these costs. The determination of stock-based compensation expense is based on many subjective inputs at a point in time and many of these inputs are not necessarily directly related to the performance of our business. Due to subjective assumptions that underlie valuation methodologies used in the calculation of this expense and the variety of stock award types that companies employ, as well as the impact of non-operational factors, such as our share price, on the magnitude of this expense, management believes that providing Adjusted EBITDA as a non-GAAP financial measure that excludes this stock-based compensation expense allows investors to make meaningful comparisons between our operating results and those of other companies.

Although Adjusted EBITDA measures are frequently used by investors and securities analysts in their evaluations of companies, Adjusted EBITDA measures each have limitations as an analytical tool, and you should not consider them in isolation or as a substitute for analysis of our results of operations as reported under GAAP.

A number of the material limitations of our use and presentation of Adjusted EBITDA include:

 

   

Adjusted EBITDA does not reflect our future requirements for contractual commitments and capital expenditures;

 

   

Adjusted EBITDA does not reflect cash interest income or expense;

 

   

Adjusted EBITDA does not reflect cash outflows for income taxes;

 

   

Adjusted EBITDA does not reflect the stock-based component of employee compensation;

 

   

although depreciation and amortization are non-cash charges that are excluded from Adjusted EBITDA, the assets being depreciated or amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any current cash requirements for these replacements; and

 

   

other companies in our industry may calculate Adjusted EBITDA or similarly titled measures differently from the manner in which we do, limiting their usefulness as comparative measures by our management or investors.

Management addresses the inherent limitations associated with using the Adjusted EBITDA measure through disclosure of such limitations, presentation of our financial statements in accordance with GAAP and reconciliation of the most directly comparable GAAP measure, net income (loss) to Adjusted EBITDA. Further, management also reviews GAAP measures, and evaluates individual measures that are not included in Adjusted EBITDA such as our level of capital expenditures and interest expense, among other items.

 

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The following provides a reconciliation of net income (loss) to Adjusted EBITDA:

 

    Year Ended December 31,  
    2007     2008     2009     2010     2011  
    (in thousands, unaudited)  

Net income (loss)

  $ (3,420   $ (4,325   $ (634   $ (17,250   $ 33,321   

Depreciation

    3,729        4,559        4,564        4,164        3,199   

Amortization and change in contingent consideration

    6,867        7,987        8,398        7,764        11,327   

Stock-based compensation expense

    610        1,770        2,510        2,404        2,244   

Interest income

    (1,403     (1,368     (851     (220     (36

Interest expense

    2,189        1,570        1,102        188        494   

Interest expense: amortization of convertible debt discount

    —          —          71        21,107        —     

Income tax provision (benefit)

    315        487        495        (1,204     (19,868

Loss (gain) on revaluation of warrants

    (360     72        (70     5,413        (351

Loss on extinguishment of debt

    340        —          356        —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 8,867      $ 10,752      $ 15,941      $ 22,366      $ 30,330   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with “Selected Consolidated Financial Information” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including but not limited to, those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We are a leading on-demand provider of tax-advantaged programs for consumer-directed health, commuter and other employee spending account benefits, or CDBs, in the United States. We administer and operate a broad array of CDBs, including spending account management programs such as health and dependent care Flexible Spending Accounts, or FSAs, Health Savings Accounts, or HSAs, Health Reimbursement Arrangements, or HRAs, and commuter benefits, such as transit and parking programs.

We deliver our CDB programs through a highly scalable Benefits-as-a-Service, or BaaS, delivery model that employer clients and their employee participants may access through a standard web browser on any internet-enabled device including computers, smart phones and other mobile devices, such as tablet computers. Our on-demand delivery model eliminates the need for our employer clients to install and maintain hardware and software in order to support CDB programs and enables us to rapidly implement product enhancements across our entire user base.

Our CDB programs enable employees and their families to save money by using pre-tax dollars to pay for certain of their healthcare and commuter expenses. Employers financially benefit from our programs through reduced payroll taxes, even after factoring in our fees. Under our FSA, HSA and commuter programs, employee participants contribute funds from their pre-tax income to pay for qualified out-of-pocket healthcare expenses not fully covered by insurance, such as co-pays, deductibles and over-the-counter medical products or for commuting costs.

These employee contributions result in savings to both employees and employers. As an example, based on our average employee participant’s annual FSA contribution of approximately $1,400 and an assumed personal combined federal and state income tax rate of 35%, an employee participant will reduce his or her taxes by approximately $490 per year by participating in an FSA. Our employer clients also realize payroll tax (i.e., FICA and Medicare) savings on the pre-tax contributions made by their employees. In the above FSA example, an employer client would save approximately $64 per participant per year, even after the payment of our fees.

Under our HRA programs, employer clients provide their employee participants with a specified amount of available reimbursement funds to help their employee participants defray out-of-pocket medical expenses such as deductibles, co-insurance and co-payments. All amounts paid by the employer into HRAs are deductible by the employer as an ordinary business expense and are tax-free to the employee.

Our company was founded in 2000 to provide the administration of tax-free commuter benefits. In early 2003, we expanded our business to include the administration of tax-advantaged healthcare programs with our FSA program. As a result of subsequent portfolio purchases made through 2006, we have broadened our CDB offerings to include HRA, HSA and Consolidated Omnibus Budget Reconciliation Act, or COBRA, programs. In 2007 we purchased MHM Resources, or MHM. The MHM small- and medium-sized business, or SMB, portfolio expanded our existing client base and the MHM technology platform enhanced our service offering to SMBs. Between 2008 and 2010, we made three portfolio purchases that have added to our client base and broadened our opportunities with public sector employers. We completed an additional portfolio purchase in early 2012 and also completed an acquisition in February 2012. For a discussion of these, see “— Recent Developments below.

 

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We market and sell our CDB programs through multiple channels, including direct sales to large enterprises, direct sales and through brokers to SMBs, and direct sales to industry purchasing and affiliate groups. Our enterprise sales force targets Fortune 1000 companies and generates new large account relationships through employer prospecting, consultant relationships and strategic partnerships. Our SMB distribution channel complements our enterprise sales channel. It consists of third-party advisors and institutional brokers that sell our CDB programs along with their own complementary products to SMBs. We also sell our services through group purchasing organizations of industry-specific employers with which we negotiate a standard service contract that covers their member entities. Our sales cycle ranges from two months for SMBs to six to nine months for our large institutional clients.

Our CDB agreements with our larger employer clients, which we refer to as enterprise clients, are typically for three-year terms and provide for monthly fees based on the number of employee participants enrolled in our programs. We price our services based on the estimated number and types of claims, whether payment processing and client support activities will be provided within or outside of the United States, the estimated number of calls to our customer support center and any specific client requirements. Almost all of the healthcare benefit plans we service on behalf of our enterprise clients are subject to contractual minimum monthly billing amounts. Generally, such minimum billing amounts are subject to upward revision on a monthly basis as our employer clients hire new employees who elect to participate in our programs, but generally are not subject to downward revision when employees leave their employers because we continue to administer those former employee participants’ accounts for the remainder of the plan year. For our SMB clients, our agreements are typically for one year and the monthly fee remains constant for the year unless there is a 10% or greater increase in the number of employee participants in which case it is subject to upward revision.

Benefit plan years customarily run concurrently with the calendar year and have an open enrollment period that typically occurs at benefit plan year-end during the fourth quarter of the calendar year. Most of our healthcare CDB agreements are executed in the last quarter of the calendar year. Because the signing of our contract often coincides with open enrollment, employer clients are able to offer our CDB programs to their employees during open enrollment for the upcoming benefit year. As a result of this timing, we are able to obtain significant visibility into our healthcare-related revenue early on in each plan year because healthcare benefit plans are administered on an annual basis, contractual revenue is based on the number of participants enrolled in our CDB programs on a per month basis and the minimum number of enrolled participants for the plan year is usually established at the close of the open enrollment period. In contrast to healthcare CDB programs, enrollment in commuter programs occurs on a monthly basis. Therefore, there is less visibility and some variability in commuter revenue from month-to-month, particularly during the summer vacation period when employee participants are less likely to participate in commuter programs for those months.

We offer prepaid debit cards for use in conjunction with almost all of the plans that we administer. These prepaid debit cards are offered in coordination with commercial banks and card associations. We receive interchange fees from employee participants’ prepaid debit card transactions, which are calculated as a percentage of the expenses transacted on each card. These interchange fees are exempt from the Durbin Amendment since there is an exception for general purpose reloadable cards and some of such cards also fall outside the definitions that establish the scope of coverage. In addition to interchange fees, we also derive revenue through our wholesale card program from fees we charge to assist third party administrators, or TPAs, in issuing our prepaid debit cards to their employee participant groups and in selling their administrative services utilizing our prepaid debit cards to new employee participants. We have historically experienced seasonality in healthcare interchange revenue, which is typically the highest during the first quarter of the year because participants are either using their newly available balances for the current plan year or spending any remaining funds available from the prior plan year during the prior plan year’s grace period. A grace period is generally established by employer clients as January 1 through March 15 of the succeeding plan year and is the period during which employee participants can access funds from the prior plan year’s FSA account. Healthcare interchange revenue generally declines through the second and third quarters and is subject to a small increase in December as some employee participants strive to use their remaining account balances before the end of the plan year.

 

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We also offer transit passes from various transit agencies, which we purchase on behalf of employee participants. Due to our significant volume, we receive commissions on these passes which we recognize as vendor commission revenue.

Our cost of revenues typically varies with our revenue and is, therefore, impacted by the seasonality of our business. We incur higher expenses in the first quarter associated with increased headcount in the form of temporary workers, consultants and other outsourced services that are required to cover the increased call volume and activity associated with the commencement of the new plan year. The need for these resources diminishes in the second and third quarters, but increases again in the fourth quarter when we provide services to our employer clients during their open enrollment periods.

At the beginning of a plan year, most of our enterprise clients provide us with prefunds for their FSA programs based on a percentage of projected elections by the employee participants for the plan year ahead. This prefunding activity covers our estimate of approximately one week of spending on behalf of the employer client’s employee participants. During the plan year, we process employee participants’ FSA claims as they are submitted and typically seek reimbursement from our employer clients within one week after settling the claim. Employer clients generally set a time after the close of a plan year when employee participants in FSA programs are allowed to continue submitting claims for the preceding plan year, which we refer to as a run-out period. At the end of the plan year and following the grace period and run-out period, as applicable, we reconcile all claims paid against the FSA prefund and return any unused funds to the employer. Prior to that point we will have already received an entirely new FSA prefund from a continuing employer client for the new plan year.

Our growth strategy includes acquiring and integrating smaller TPAs to expand our employer client base. We refer to these acquisitions as portfolio purchases.

Consistent with this acquisition strategy, we have made five portfolio purchases since 2007, which include MHM in September 2007, Creative Benefits, or CB, in September 2008, Planned Benefit Systems, or PBS, in August 2010, the CDB assets of a division of Fringe Benefits Management Company, or FBM, in November 2010, and the assets of The Choice Care Card, LLC, also known as Choice Strategies, or CS, in January 2012. In addition, we completed one acquisition, in which we acquired the operating assets of TransitCenter, Inc. (a business we refer to as TransitChek or TC) in early 2012. For a discussion of the CS and TC transactions, see “—Recent Developments.” These portfolio purchases have enabled us to expand our employer client base, particularly in the SMB and public sector markets, and provided an opportunity to cross-sell additional CDB services to our newly acquired employer clients. The purchases of CB and PBS increased our COBRA service offerings, and the purchase of the FBM portfolio expanded our service capabilities to public sector clients. Our model for these portfolio purchases generally involves a payment at closing of the transaction and contingent payments based on retention of the acquired client accounts and achievement of revenue growth targets. Portfolio purchases may have a material adverse impact on our results of operations, including a potential material adverse impact on our cost of revenues in the short term as we seek to migrate acquired clients to our proprietary technology platforms, typically over the succeeding 12 to 24 months, in order to achieve additional operating efficiencies. There are several hundred regional TPA portfolios that we continually monitor and evaluate in order to maintain a robust pipeline of potential candidates for purchase and we intend to continue executing our focused strategy of portfolio purchases to broaden our employer client base. The acquisition of TC enabled us to further expand our commuter tax-advantaged benefit offerings in the SMB market with products tailored to SMB needs. We believe this acquisition will help solidify our position as a leading provider of commuter-related CDBs.

We monitor our operating results and take steps to improve, redirect and consolidate our operations. In April 2009, we reorganized a number of operational areas to enable key personnel to focus solely on supporting either our healthcare or commuter programs. In addition, we reduced and reorganized our client services team to focus on specific regions. We also took actions to reduce our fixed personnel costs and increase our variable outsourcing costs. These activities have provided us with increased resource flexibility during our seasonal peaks in service delivery. In the first quarter of 2012, we closed our Troy, Michigan facility and consolidated redundant activities within our operations, which resulted in the elimination of certain personnel. The expenses related to these actions will be approximately $0.5 million.

 

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Recent Developments

Choice Strategies Portfolio Purchase

On January 3, 2012, we acquired all of the operating assets of The Choice Care Card, LLC, also known as Choice Strategies, or CS, a third party administrator of predominantly SMB HRA accounts, based in Vermont. CS added approximately 5,100 employer clients, primarily in New England, to our existing business.

TransitCenter Asset Acquisition

On February 1, 2012, we acquired all of the operating assets of TransitCenter, Inc., a not for profit entity based in New York that conducted a business that we refer to as TransitChek, or TC. TC is exclusively focused on tax advantaged programs for consumer-directed commuter benefits (transit and parking) and serves approximately 10,000 predominantly SMB employer clients largely concentrated in the New York tri-state area.

TC offers two variations of commuter programs—Basic and Premium. The Basic program involves bulk shipping transit and parking passes to an employer, which the employer, in turn, distributes to its employees. The Basic program is billed based on the total face value of the transit and parking pass order. The Premium program is similar to our current commuter programs in which the transit pass is distributed directly to the employer client’s employees. The Premium program bills employer clients on a per participant per month basis, consistent with our existing commuter programs.

The consideration for these two transactions totaled $39.9 million. Of this amount, $39.1 million was paid in January and February 2012. These payments were primarily financed through our revolving credit facility with Union Bank, N.A. There are additional possible contingent payments due in 2012 and 2013 based on the achievement of certain revenue levels. We currently anticipate that the future contingent payments for these two transactions will total approximately $14 million to $16 million. However, this estimate is preliminary and may change, potentially materially, based on the actual revenue milestones achieved.

For more information about the TC transaction see Note 16 to our consolidated financial statements for the fiscal year ended December 31, 2011, TC’s audited financials and our proforma condensed consolidated financial statement information included elsewhere in this prospectus.

Adjusted EBITDA

In addition to traditional financial measures, we monitor our Adjusted EBITDA to help us evaluate the effectiveness and efficiency of our operations. Adjusted EBITDA is not a recognized presentation in accordance with generally accepted accounting principles in the United States, or GAAP. The table immediately following this discussion provides a reconciliation of net income (loss), which is the most directly comparable GAAP measure, to this non-GAAP measure. Adjusted EBITDA should not be considered as an alternative to net income, income from operations or any other measure of financial performance calculated and presented in accordance with GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of other companies because other companies may not calculate Adjusted EBITDA or similarly titled measures in the same manner that we do. We prepare Adjusted EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. For further discussion on Adjusted EBITDA, see footnote 2 to “Selected Consolidated Financial Information.”

 

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The following provides a reconciliation of net income (loss) to Adjusted EBITDA:

 

     Year Ended December 31,  
     2009     2010     2011  
     (in thousands)  
     (unaudited)  

Net income (loss)

   $ (634   $ (17,250   $ 33,321   

Depreciation

     4,564        4,164        3,199   

Amortization and change in contingent consideration

     8,398        7,764        11,327   

Stock-based compensation expense

     2,510        2,404        2,244   

Interest income

     (851     (220     (36

Interest expense

     1,102        188        494   

Interest expense: amortization of convertible debt discount

     71        21,107        —     

Income tax provision (benefit)

     495        (1,204     (19,868

Loss (gain) on revaluation of warrants

     (70     5,413        (351

Loss on extinguishment of debt

     356        —          —     
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 15,941      $ 22,366      $ 30,330   
  

 

 

   

 

 

   

 

 

 

Key Components of Our Results of Operations

Revenue

We generate revenue from three major sources: healthcare solutions, commuter solutions and other services.

Healthcare Revenue

We derive our healthcare revenue from the service fees paid by our employer clients for the administration services we provide in connection with their employee participants’ healthcare FSA, dependent care FSA, HRA and HSA tax-advantaged accounts. Our fee is generally fixed for the duration of the written agreement with our employer client, which is typically three years for our enterprise clients and one year for our SMB clients. These fees are paid to us on a monthly basis by our employer clients, and the related services are made available to employee participants pursuant to written agreements between us and each employer client. Almost all of the healthcare benefit plans we service on behalf of our enterprise employer clients are subject to contractual minimum monthly billing amounts. Generally, such minimum billing amounts are subject to upward revision on a monthly basis as our employer clients hire new employees who elect to participate in our programs, but generally are not subject to downward revision when employees leave their employers because we continue to administer those former employee participants’ accounts for the remainder of the plan year. For SMB employer clients, the monthly fee remains constant for the plan year unless there is a 10% or greater increase in the number of employee participants in which case it is subject to upward revision. Revenue is recognized monthly as services are rendered under our written service agreements.

We also earn interchange revenue from debit cards used by employee participants in connection with all of our healthcare programs and through our wholesale card program, which we recognize monthly based on reports received from third parties.

Commuter Revenue

We derive our commuter revenue from monthly service fees paid by our employer clients, interchange revenue that we receive from debit cards used by employee participants in connection with our commuter solutions and revenue from the sale of transit passes used in our commuter solutions. Our fees from employer clients are normally paid monthly in arrears based on the number of employee participants enrolled for the month. Most agreements have volume tiers that adjust the per participant price based upon the number of participants enrolled during that month. Revenue is recognized monthly as services are rendered under these written service agreements.

 

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We earn interchange revenue from the debit cards used by employee participants in connection with our commuter programs, which we recognize monthly based on reports received from third parties.

We also receive commissions from transit passes, which we purchase from various transit agencies on behalf of employee participants. Due to our significant volume, we receive commissions on these passes which we recognize as vendor commission revenue.

TC derives revenue from two programs that are similar in size: Basic and Premium. Revenue from the Basic program is based on a percentage of the face value of the transit and parking passes ordered by employer clients and revenue from the Premium program is derived from monthly service fees paid by employer clients. TC also earns commissions from the sale of transit passes and interchange from the use of debit cards by employee participants in connection with our pre-tax commuter benefit programs. In addition, revenue is recognized on expired passes as the amounts paid for these passes are nonrefundable to both the employer client and the employer participant.

Other Revenue

We derive other revenue primarily from our provision of COBRA administration services to employer clients for continuation of coverage for participants who are no longer eligible for the employer’s health benefits, such as medical, dental, vision, and for the continued administration of the employee participants’ HRAs and certain healthcare FSAs. Our agreements to provide COBRA services are not consistently structured and we receive fees based on a variety of methodologies. Other services also include enrollment and eligibility services, employee account administration (i.e., tuition and health club reimbursements) and project-related professional fees. Other services revenue is recognized as services are rendered under our written service agreements.

Costs and Expenses

Cost of Revenues (excluding the amortization of internal use software)

Cost of revenues includes the costs of providing services to our employer clients’ employee participants.

The primary component of cost of revenues is personnel and the expenses related to our claims processing, product support and customer service personnel. Cost of revenues includes outsourced and temporary help costs, check/ACH payment processing services, debit card processing services, shipping and handling costs for cards and passes and employee participant communications costs.

Cost of revenues also includes the losses or gains associated with processing our large volume of transactions, which we refer to as “net processing losses or gains.” In the normal course of our business, we make administrative and processing errors that we cannot bill to our employer clients. For example, we may over-reimburse employee participants for claims they submit or incur the cost of replacing commuter passes that are not received by employee participants. Upon identifying such an error, we record the expense as a processing loss. In certain circumstances, we experience recoveries with respect to these amounts which are recorded as processing gains.

Cost of revenues does not include amortization of internal use software, which is included in amortization, or the cost of operating on-demand technology infrastructure, which is included in technology and development expenses.

Technology and Development

Technology and development expenses include personnel and related expenses for our technology operations and development personnel as well as outsourced programming services, the costs of operating our on-demand technology infrastructure, depreciation of equipment and software licensing expenses. During the planning and post-implementation phases of development, we expense, as incurred, all internal use software and website development expenses associated with our proprietary BaaS model. During the development phase, costs

 

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incurred for internal use software are capitalized and subsequently amortized once the software is available for its intended use. Expenses associated with the platform content or the repair or maintenance of the existing platforms are expensed as incurred.

Sales and Marketing

Sales and marketing expenses consist primarily of personnel and related expenses for our sales, client services and marketing staff, including sales commissions for our direct sales force, as well as communication, promotional, public relations and other marketing expenses.

General and Administration

General and administration expenses include personnel and related expenses of and professional fees incurred by our executive, finance, legal, human resources and facilities departments.

Amortization and Change in Contingent Consideration

Amortization and change in contingent consideration expense includes amortization of internal use software, amortization of acquired intangible assets and changes in contingent consideration in connection with portfolio purchases and acquisitions.

We capitalize internal use software and website development costs incurred during the development phase and we amortize these costs over the technology’s estimated useful life, which is generally four years. These capitalized costs include personnel costs and fees for outsourced programming and consulting services.

We also amortize acquired intangible assets consisting primarily of employer client agreements and relationships and broker relationships. Employer client agreements and relationships and broker relationships are amortized on a straight-line basis over an average estimated life that ranges from four to ten years.

We measure acquired contingent consideration payable each reporting period at fair value and recognize changes in fair value in our consolidated statement of operations each period, until the final amount payable is determined. Increases or decreases in the fair value of the contingent consideration payable can result from changes in revenue forecasts and risk and probability assumptions. Significant judgment is employed in determining the appropriateness of these assumptions in each period.

Other Income (Expense)

Other income (expense) consists of (i) interest income; (ii) interest expense; (iii) interest expense: amortization of convertible debt discount; and (iv) gain (loss) on revaluation of warrants.

Interest Expense: Amortization of Convertible Debt Discount

On December 28, 2009, we entered into a convertible note agreement with several of our existing preferred stockholders. This transaction resulted in a debt discount of $20.0 million that was fully amortized during 2010. Amortization of convertible debt discount also includes accrued interest on our promissory notes that were converted in July 2010.

Gain (Loss) on Revaluation of Warrants

Preferred warrant liabilities are the result of warrants issued in connection with previous debt financings. We account for those freestanding warrants that are exercisable into shares of potentially redeemable preferred stock as liabilities by marking-to-market those warrants at each reporting period from the warrant issuance date until their exercise date or expiration. The changes resulting from marking-to-market are presented in our consolidated statements of operations as gain (loss) on revaluation of warrants. Warrants issued in connection with our 2009 debt financing were modified on July 30, 2010 to be exercisable for Series E-1 preferred shares that are not redeemable. Accordingly, these warrants were reclassified at that date from debt to equity and were

 

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no longer subject to mark-to-market changes. Upon the completion of this offering, all outstanding shares of our preferred stock will automatically convert into shares of common stock and the warrants to purchase Series E-1 preferred stock and the remaining warrants to purchase Series C preferred stock will either be voluntarily exercised by the holders for shares of common stock or will, in accordance with their terms, automatically convert into warrants to purchase common stock. At that time, we will no longer record any changes in the fair value of these warrants in our consolidated statement of operations.

Provision for Income Taxes

We are subject to taxation in the United States. In 2011, our effective tax rate differed from the statutory rate primarily due to the 2011 release of our valuation allowance on our net deferred tax assets, state taxes and the increases in the contingent payments related to our PBS and FBM acquisitions, which increases are not deductible for tax purposes. Prior to 2011, our effective tax rate differed from the statutory rate primarily due to the valuation allowance on the majority of our net deferred tax assets. For future periods, we expect our effective tax rate to approximate the U.S. federal statutory tax rates before adjusting for the effects of credits and state taxes.

As of December 31, 2011, we had $47.9 million of federal and $38.9 million of state net operating loss carryforwards available to offset future taxable income. If not fully utilized, these net operating loss carryforwards will expire beginning in 2023 through 2029 for U.S. federal income tax purposes, and beginning in 2012 through 2031 for state income tax purposes. In addition, we have federal and state research and development credit carryforwards of $2.6 million and $1.1 million, respectively. The federal research credit carryforwards expire beginning in the years 2022 through 2031, if not fully utilized. The California research credit carries forward indefinitely. Our ability to utilize net operating loss and tax credit carryforwards in the future may be subject to substantial restriction under applicable law, including in the event of past or future ownership changes as defined in Section 382 of the Internal Revenue Code of 1986, as amended and similar state law (including in connection with this offering), which ownership changes may be outside of our control.

We make estimates and judgments about our future taxable income that are based on assumptions that are consistent with our plans and estimates. Should the actual amounts differ from our estimates, our provision for income taxes could be materially affected.

Accretion of Redemption Premium

Certain of our series of preferred stock are redeemable after December 31, 2012 at the election of the majority of the preferred stockholders. This redemption option is only available to the extent a qualified offering has not been consummated as of December 31, 2012. A qualified offering is an initial public offering in which net proceeds from the sale of our common stock are $40 million or greater and the offering price per share is at least $20.78, as adjusted for any stock dividends, combinations or splits with respect to such shares. To the extent that the redemption is requested, the holders will receive the greater of the fair value of the preferred stock at the time of redemption and the original issuance price. We account for this redemption premium by recording accretion charges reflecting the changes in the redemption value over the period from the date of issuance to the earliest redemption date, which is December 31, 2012. Upon the completion of this offering, the redeemable preferred shares will convert to common shares and we will not record any further accretion.

Critical Accounting Policies and Significant Management Estimates

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles, or GAAP, in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances, changes in the accounting estimates are reasonably likely to occur from period-to-period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

 

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In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We believe that there are several accounting policies that are critical to understanding our business and prospects for future performance, as these policies affect the reported amounts of revenue and other significant areas that involve management’s judgment and estimates. These significant policies and our procedures related to these policies are described in detail below. In addition, please refer to the “Notes to Consolidated Financial Statements” for further discussion of our accounting policies.

Revenue Recognition

We report revenue for the following programs: healthcare, commuter and other services.

Healthcare and commuter programs include revenues generated from benefit service fees based on employee participant levels, interchange and other commission fees.

Most of our employee participants utilize prepaid debit cards to pay for their qualified healthcare and commuter expenses and we receive fees, known as interchange, that represent a percentage of the expenses transacted on each card. We also receive commissions from transit passes that we purchase from various transit agencies on behalf of employee participants. Due to our significant volume, we receive commissions on these passes which we recognize as vendor commission revenue.

We recognize revenue when the following criteria are met: collectibility is reasonably assured, delivery has occurred, persuasive evidence of an arrangement exists and there is a fixed or determinable fee. These criteria are generally met each month as we deliver services to our employer clients and their employee participants.

Valuation of Long-Lived Assets

Long-lived assets, such as property, equipment, acquired intangibles and capitalized internal use software subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable such as: (i) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (ii) a significant adverse change in legal factors or in the business climate that could affect its value, or (iii) a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with its use.

Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. An asset group is the lowest level at which cash flows can be identified that are largely independent of the cash flows of other asset groups. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. With the exception of MHM, we have determined that the entity level is the lowest level at which cash flows can be identified that are largely independent of the cash flows of other assets and liabilities as our revenue is interdependent on the revenue-producing activities and significant shared operating activities of all long-lived assets. The entity level is the aggregation of our three revenue streams arising from the administration of employer client sponsored healthcare programs, commuter programs and other programs. In addition to the undiscounted future cash flows expected to be generated at an entity level, we also consider other available information such as our total enterprise value determined for the purpose of estimating the fair value of our common stock, as further discussed below, in assessing the fair value of the entity level asset group. We have identified the long-lived assets of MHM as a separate asset group because we believe that the financial information available is sufficient to determine the cash inflows and outflows of certain MHM assets. Management evaluates the remaining useful lives of these assets on an annual basis and tests for impairment

 

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whenever events or changes in circumstances occur that could impact the recoverability of these assets. We recorded impairment adjustments of $345,000, $120,000 and $116,000 in 2009, 2010 and 2011 respectively, related to software development costs.

We perform an annual goodwill impairment test on December 31st and more frequently if events and circumstances indicate that the asset might be impaired. The impairment tests are performed in accordance with FASB ASC 350, Intangibles—Goodwill and Other, or ASC 350. An impairment loss is recognized to the extent that the carrying amount exceeds the reporting unit’s fair value. The goodwill impairment analysis is a two-step process: First, the reporting unit’s estimated fair value is compared to its carrying value, including goodwill. If we determine that the estimated fair value of the reporting unit is less than its carrying value, we move to the second step to determine the implied fair value of the reporting unit’s goodwill. If the carrying amount of the reporting unit’s goodwill exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of the reporting unit’s goodwill in a manner similar to a purchase price allocation.

When reviewing goodwill for impairment, we assess whether goodwill should be allocated to operating levels lower than our single operating segment for which discrete financial information is available and reviewed for decision-making purposes. These lower levels are referred to as reporting units. Currently, we aggregate the following three revenue streams, healthcare, commuter and other into a single reporting unit in accordance with ASC 350.

The fair value of our reporting unit was determined using the market approach. In the application of the market approach, we are required to make estimates of future operating trends and judgments on discount rates and other variables. Actual future results related to assumed variables could differ from these estimates. Discount rates are based on a weighted average cost of capital, which represents the average rate a business must pay its providers of debt and equity capital. We used discount rates that are the representative weighted average cost of capital for our reporting unit in comparison with peer companies, with consideration given to the current condition of the global economy. We determine projected income based on our best estimate of near term revenue and Earnings before Interest, Income Taxes, Depreciation and Amortization, or EBITDA, expectations and long-term projections. Estimated Adjusted EBITDA for 2011 increased as compared to 2010. As a sensitivity analysis, a 100 basis point reduction in the assumed net sales growth beginning in 2012 would decrease minimally the overall valuation but it would not cause a change in the results of our impairment testing that indicated no impairment of goodwill.

As of the end of our fourth quarter of 2011, the period of our last annual impairment test, the fair value of our reporting unit determined under the market approach exceeded our aggregate carrying value by a significant amount. To date, we have not made any impairment adjustments to goodwill as the fair value of our reporting unit has always exceeded our carrying value.

Income Taxes

We are subject to income taxes in the United States. Significant judgments are required in determining the consolidated provision for income taxes.

We use the asset and liability method to account for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and net operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We record a valuation allowance to reduce deferred tax assets to an amount whose realization is more likely than not.

 

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During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes and interest will be due. These tax liabilities are recognized when, despite the belief that our tax return positions are supportable, we believe that certain positions may not be more likely than not of being sustained upon review by tax authorities. As of December 31, 2011, our unrecognized tax benefits approximated $2.3 million, and we have no uncertain tax positions that would be reduced as a result of a lapse of the applicable statute of limitations. We believe that our accruals for tax liabilities are adequate for all open audit years based on our assessment of many factors, including past experience and interpretations of tax law. This assessment relies on estimates and assumptions and may involve a series of complex judgments about future events. We do not anticipate any adjustments would result in a material change to our financial position. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact income tax expense in the period in which such determination is made. We recognize accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense.

Management periodically evaluates if it is more likely than not that some or all of the deferred tax assets will be realized. In making such determination, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial performance. In order to support a conclusion that a valuation allowance is not needed, positive evidence of sufficient quantity and quality (objective compared to subjective) is necessary to overcome negative evidence. During 2009 and 2010, management determined there was significant negative evidence and concluded that it was more likely than not that the net deferred tax assets would not be realized and accordingly established a valuation allowance on our deferred tax asset balance. The lack of profitability in prior years is a significant piece of negative evidence and generally precludes management’s estimate of forecasted future taxable income as positive evidence in its assessment. As a result, a valuation allowance on our deferred tax asset balance was recognized for the net deferred tax assets as of December 31, 2010.

In the fourth quarter of 2011, we determined, based on our recent history of taxable income coupled with our forecasted profitability and enrollments that occurred in the fourth quarter that continued to show growth and stability in the number of employee participants enrolling and being retained, that it is more likely than not that $24.7 million of deferred tax assets as of December 31, 2011 will be realized in the foreseeable future and a valuation allowance should no longer be maintained against the remaining deferred tax assets. Accordingly, in the fourth quarter of 2011, we released the valuation allowance on our deferred tax assets of $25.9 million, primarily related to our federal deferred tax assets.

In the future, if there is a significant negative change in our operating results or the other factors that were considered in making this determination, we could be required to record a valuation allowance against our deferred tax assets. Any subsequent increases in the valuation allowance will be recognized as an increase in deferred tax expense. Any decreases in the valuation allowance will be recorded either as a reduction of the income tax provision or as a credit to paid-in capital if the associated deferred tax asset relates to windfall stock option deductions on the exercise of stock options.

 

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Stock-Based Compensation

Stock-based compensation for stock awards is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes option pricing model and is recognized as an expense over the requisite service period. The determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price and related volatility over the expected term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate, estimated forfeitures and expected dividends. The following table sets forth the assumptions made with respect to these issues during 2009, 2010 and 2011.

 

    

December 31,

    

2009

  

2010

  

2011

                

Expected term (in years)

   4.95-6.06    6.07    5.47-6.08

Risk-free interest rate

   2.13-2.72%    1.19-2.51%    2.18-2.72%

Expected volatility

   47.0%    46.0-50.9%    54.72-56.09%

Dividend yield

   0.00%    0.00%    0.00%

We changed our method of estimating expected term in 2010 from using historical and observed exercises to using the “simplified” method as an estimate of expected term. We based the risk-free interest rate on zero-coupon yields implied from U.S. Treasury issues with remaining terms similar to the expected term on the options. We estimate expected volatility based on the historical volatility of comparable companies from a representative peer-group. We do not anticipate paying any cash dividends in the foreseeable future, and therefore, used an expected dividend yield of zero in the option pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We true-up our forfeitures monthly to vested amounts. If we use different assumptions for estimating stock-based compensation expense in future periods, or if actual forfeitures differ materially from our estimated forfeitures, future stock-based compensation expense may differ significantly from what we have recorded in the current period and could materially affect our income (loss) from operations, net income (loss) and net income (loss) per share.

Given the absence of an active market for our common stock, our stock price at any given time is determined by our board of directors, which considers numerous objective and subjective factors at each option grant date, including the following:

 

   

contemporaneous valuations performed by an independent valuation firm, generally as of specified dates;

 

   

prices for our preferred stock sold to outside investors in arms-length transactions, and the rights, preferences and privileges of our preferred stock and our common stock;

 

   

secondary sales of shares of our common stock, if any;

 

   

our actual financial condition and results of operations relative to our operating plan during the relevant period;

 

   

forecasts of our financial results and overall market conditions; and

 

   

the likelihood of achieving a liquidity event for the shares of common stock underlying the options such as an initial public offering or sale of the company, or remaining a private company, given prevailing market conditions at the time of grant.

Our board of directors believes that the judgment required in such efforts necessarily involves an element of subjectivity.

 

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Valuations performed by the independent valuation firm were conducted in accordance with methods specified by the AICPA Practice Aid on “Valuation of Privately-Held Company Equity Securities Issued as Compensation.” The valuations performed by the independent valuation firm used the Probability Weighted Expected Result Method, or PWERM, to arrive at a weighted equity value. The PWERM methodology requires the consideration of various liquidity scenarios, including an initial public offering and a sale of our company, as well as continuing as a standalone privately-held company, and takes into account potential timing and the relative probability of each possible outcome. The probabilities for each outcome were based on discussions with management. The PWERM was also used to allocate the value among the various issues of preferred shares and considered differences between our preferred and common stock with respect to liquidation preferences, conversion rights, voting rights and other features. The valuations used in the PWERM allocation primarily considered the public company market multiple method. The public company market multiple method focuses on comparing our company to similar publicly traded entities. The valuations for June 30, 2010 and prior also used the income approach as a weighted factor in valuing the standalone scenario. The income approach involves applying appropriate risk-adjusted discount rates to estimated debt-free cash flows, based on forecasted revenues and costs. The discount rate applied to our cash flows was based on a weighted average cost of capital, which represents the blended, after-tax costs of debt and equity. The projections used in connection with these valuations were based on our expected operating performance over the forecast period. Beginning with its December 31, 2010 valuation report, our independent valuation appraiser noted that the use of the market approach was a more appropriate valuation methodology than the income approach based on the anticipated timing of our planned initial public offering. The valuation appraiser determined that the increased probability of an initial public offering scenario in the relatively near term was indicative of our anticipated time to exit being substantially less than the period used for a discounted cash flow analysis under the income approach. The market approach was corroborated by the implied enterprise value from the PWERM.

We considered appropriate adjustments in light of the lack of marketability of shares of our common stock and calculated our results based upon variables for cost of capital (20-25%). The following table summarizes the concluded discount for lack of marketability as of the valuation dates noted:

 

Valuation Date

   Discount for
Lack of
Marketability
    Value per
Share of
Common Stock
 

As of December 31, 2008

     15.0   $ 6.14   

As of June 30, 2009

     15.0        7.42   

As of December 31, 2009

     11.7        5.32   

As of June 30, 2010

     9.6        6.18   

As of December 31, 2010

     12.4        10.98   

As of March 31, 2011

     9.5        12.10   

As of June 30, 2011

     7.0        12.84   

As of December 31, 2011

     10.1        9.59   

No other discounts were applied to arrive at the fair value amount, other than the lack of marketability discount discussed above.

 

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The following table summarizes the number of options granted and the value of the common stock at each grant date:

 

Grant Date

   Number of
Shares
Underlying
Options Granted
     Exercise Price
per Share
     Common Stock
Fair Value per
share at Grant
Date
     Intrinsic Value
per Share at
Grant Date
     Weighted
Average
Stock Option
Fair Value at
Grant Date
 

May 7, 2009

     155,250       $ 6.14       $ 6.14         —         $ 2.64   

May 29, 2009

     592,875         6.14         6.14         —           2.66   

November 4, 2009

     68,750         7.42         7.42         —           3.58   

December 15, 2009

     107,500         7.42         7.42         —           3.58   

April 1, 2010

     39,375         5.32         5.32         —           2.62   

May 6, 2010

     757,375         5.32         5.32         —           2.70   

August 24, 2010

     41,255         6.18         6.18         —           2.79   

November 4, 2010

     299,250         6.18         6.18         —           3.38   

February 15, 2011

     106,250         10.98         10.98         —           5.98   

May 5, 2011

     32,375         12.10         12.10         —           6.42   

February 9, 2012

     791,875         9.59         9.59         —           5.34   

If we assumed a 100 basis point change, but not below zero, in the following assumptions or a one-year change in the expected life, the value of stock option grants in 2011 would increase (decrease) by the following percentages:

 

     +100 Basis Points     -100 Basis Points  

Expected life

     4.1     (4.5 )% 

Expected volatility

     1.2     (1.2 )% 

Risk-free interest rate

     2.8     (2.7 )% 

At each option grant date, our board of directors considers the most recent contemporaneous valuation from an independent third party valuation report. Our board considers the shelf life of that valuation as provided in the AICPA Practice Aid on “Valuation of Privately-Held-Company Equity Securities Issued as Compensation.” The significant factors considered in determining the valuation of common stock at the option grant dates were as follows:

May 7, 2009 and May 29, 2009 grant dates

Our board obtained a contemporaneously prepared valuation from an independent third party valuation expert as of December 31, 2008. The decline in fair value at December 2008 to $6.14 per common share was primarily due to the significant decline in general economic and financial conditions, as reflected by the declines in gross domestic product, or GDP, in the fourth quarter of 2008 and was also attributable to our decision to postpone our initial public offering, or IPO, and therefore decrease its weighting in valuing our common stock. Our board considered the independent valuation at December 31, 2008 and reviewed and considered that valuation along with other relevant factors it deemed important in each valuation, including:

 

   

our interim activity and operating and financial performance for the period from January 1, 2009 to May 1, 2009;

 

   

general economic conditions and the specific outlook for our industry;

 

   

the likelihood of achieving different liquidity events or remaining a private company; and

 

   

significant events or changes at our company.

Our board determined there were no significant changes in relevant factors since the valuation date of December 31, 2008. Accordingly, our board determined the December 31, 2008 valuation ($6.14) to be the fair value of our common stock for the May 2009 grants.

 

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November 4, 2009 and December 15, 2009 grant dates

Our board obtained a contemporaneously prepared valuation from an independent third party valuation expert as of June 30, 2009. The increase in fair value at June 2009 to $7.42 per common share was due to the recovery in the public market following the significant decline in the general economic and financial conditions in the fourth quarter of 2008. Our board considered the most recent available independent valuation at June 30, 2009 along with other relevant subjective factors, including:

 

   

our operating and financial performance and interim activity for the period from July 1, 2009 through November 1, 2009 and December 1, 2009, respectively;

 

   

general economic conditions and the specific outlook for our industry,

 

   

the likelihood of achieving different liquidity events or remaining a private company; and

 

   

significant events or changes at our company.

Our board determined there were no significant changes in relevant factors since the valuation date of June 30, 2009. Accordingly, our board determined the June 30, 2009 valuation ($7.42) to be the fair value of our common stock for the November and December 2009 grants.

April 1, 2010 and May 6, 2010 grant dates

Our board obtained a contemporaneously prepared valuation from an independent third party valuation expert as of December 31, 2009. In December 2009, substantial improvement in the stock market increased the liquidity strategy values and we showed a year-over-year value increase in value of total weighted equity; however, we had a $20 million convertible debt financing that was treated as dilutive for valuation purposes and reduced the per common share fair value to $5.32. Economic conditions were flat for the period December 2009 through May 2010 and economic reports were mixed with strong recoveries predicted but considerable debate and disagreement over sustainability. Our board considered the most recent available independent valuation as of December 31, 2009 along with other relevant factors, including:

 

   

our operating and financial performance for the period from January 1, 2010 through April 1, 2010 and May 1, 2010, respectively;

 

   

general economic conditions, including the improvement in the public market and the specific outlook for our industry;

 

   

the likelihood of achieving different liquidity events; and

 

   

significant events or changes at our company.

Our board determined there were no significant changes in relevant factors since the valuation date of December 31, 2009. Accordingly, our board determined the December 31, 2009 valuation ($5.32) to be the fair value of our common stock for the May 2010 grants.

August 24, 2010 and November 4, 2010 grant dates

Our board obtained a contemporaneously prepared valuation from an independent third party valuation expert as of June 30, 2010. The increase in value to $6.18 from December 31, 2009 to June 30, 2010 was primarily the result of growth in operating profits and Adjusted EBITDA as well as increased weighting of a potential IPO. Our board again considered the most recent independent valuation available as of June 30, 2010 along with other relevant objective and subjective factors, including:

 

   

our operating and financial performance for the period from July 1, 2010 through August 1, 2010 and November 1, 2010, respectively;

 

   

general economic conditions, noting that for the one-month period ending August 1, 2010 and four-month period ending November 1, 2010 the public market was flat;

 

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the specific outlook for our industry and the likelihood of achieving different liquidity events or remaining a private company; and

 

   

significant events or changes at our company.

Our board determined there were no significant changes in relevant factors since the valuation date of June 30, 2010. Accordingly, our board determined the June 30, 2010 valuation ($6.18) to be the fair value of our common stock for the August 2010 and November 2010 grants.

February 15, 2011 grant date

Our board obtained a contemporaneously prepared valuation from an independent third party valuation expert as of December 31, 2010. The valuation showed an increase in value from the June 30, 2010 valuation to $10.98 per share. The increase as of December 31, 2010, was due in part to the acquisition of FBM in December leading to our increased penetration into the public sector market and the increased weighting of a potential IPO in the valuation. The increase in the IPO scenario weighting was due to management and our board taking steps towards readying us for an initial public offering. Those steps included the holding of a pre-IPO organizational meeting in mid-December, and the initiation of the preparation of an offering document. Our board considered the most recent available independent valuation as December 31, 2010 along with other relevant factors, including:

 

   

general economic conditions and the specific outlook for our industry;

 

   

the proximity of the grant date of February 15, 2011;

 

   

the increased likelihood of achieving an IPO noted above; and

 

   

significant events or changes at our company.

Our board determined there were no significant changes in relevant factors since the valuation date of December 31, 2010. Accordingly, our board determined the December 31, 2010 valuation ($10.98) to be the fair value of our common stock for the February 2011 grants.

May 5, 2011 grant date

Our board obtained a contemporaneously prepared valuation from an independent third party valuation expert as of March 31, 2011. The increase in fair value at March 31, 2011 to $12.10 per common share from the December 31, 2010 valuation of $10.98 was primarily due to the increase in the IPO scenario weighting in the valuation. The increase in the IPO scenario weighting was due to our moving closer to an initial public offering. Our board considered the independent valuation at March 2011 and reviewed and considered that valuation along with other relevant factors it deemed important in each valuation, including:

 

   

our interim activity and operating and financial performance for the period from March 31, 2011 through May 1, 2011;

 

   

general economic conditions and the specific outlook for our industry;

 

   

the likelihood of achieving different liquidity events or remaining a private company; and

 

   

significant events or changes at our company.

Our board determined there were no significant changes in relevant factors since the valuation date of March 31, 2011. Accordingly, our board determined the March 31, 2011 valuation ($12.10) to be the fair value of our common stock for the May 5, 2011 grants.

 

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February 9, 2012 grant date

Our board obtained a contemporaneously prepared valuation from an independent third party valuation expert as of December 31, 2011. The decline in fair value at December 31, 2011 to $9.59 per common share from the June 30, 2011 valuation of $12.84 was primarily due to the decrease in the applicable multiples based upon our public company comparable analysis. Additionally, increases in stock market volatility resulted in an increase in the estimated discount for lack of marketability. Our board considered the independent valuation at December 31, 2011 and reviewed and considered that valuation along with other relevant factors it deemed important in each valuation, including:

 

   

our interim activity and operating and financial performance for the period from June 30, 2011 through February 9, 2012;

 

   

general economic conditions and the specific outlook for our industry;

 

   

the likelihood of achieving different liquidity events or remaining a private company; and

 

   

significant events or changes at our company.

Our board determined there were no significant changes in relevant factors since the valuation date of December 31, 2011. Accordingly, our board determined the December 31, 2011 valuation ($9.59) to be the fair value of our common stock for the February 9, 2012 grants.

Fair Value of Warrants

We record warrants issued in connection with our debt financings based on their fair value on the grant date and adjust quarterly based on a mark-to-market valuation. The change in estimated fair value is classified as “Gain (loss) on revaluation of warrants” in our consolidated statement of operations.

In connection with a May 23, 2005 debt financing, we granted a warrant, or the Lender Warrant, to purchase 423,529 shares of Series C preferred stock at a purchase price of $4.25 per share. The Lender Warrant is classified as a liability on our consolidated balance sheet in accordance with ASC 480. The warrant is exercisable, in whole or in part, until the earliest of May 23, 2015 or 18 months after an initial public offering of our common stock. We value the Lender Warrant using an option pricing valuation model, and for 2009-2011 the assumptions were: expected term (1.75 – 3.5 years); risk-free interest rates (0.22% – 1.56%); dividend of 0%; fair value of underlying shares ($5.14 – $7.55) and volatility (43.4% – 56.4%). Upon the completion of this offering, the Lender Warrant will either be exercised for shares of common stock or converted to a warrant to purchase common stock. At that time, we will no longer record any changes in the fair value of these warrants in our consolidated statement of operations.

If we assumed a 100 basis point change, but not below zero, in the following assumptions or a one-year change in the expected life, the value of the Lender Warrant would increase (decrease) by the following percentages:

 

     +100 Basis Points     -100 Basis Points  

Expected life

     10.5     (13.7)

Expected volatility

     0.7     (0.8)

Risk-free interest rate

     1.4     (0.4)

In connection with a December 28, 2009 debt financing, we granted warrants, or the Investor Warrants, to purchase $20 million worth of Series E preferred stock. From December 28, 2009 through July 30, 2010, the Investor Warrants were classified as liabilities on our consolidated balance sheet in accordance with ASC 480 as these warrants are exercisable into redeemable shares. On July 30, 2010, the terms of the Investor Warrants were amended to allow for conversion to Series E-1 preferred stock, which is not redeemable. As a result, the Investor Warrants were reclassified from a liability to equity on July 30, 2010, and changes in the fair value of these

 

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warrants have not been recorded in our consolidated statement of operations after the third quarter of 2010. We valued the Investor Warrants from December 28, 2009 through July 30, 2010 using an option pricing valuation model with assumptions that ranged as follows: fair value of the underlying shares ($3.42 – $3.98); risk-free interest rates (0.84% – 2.68%); expected term (2.89 – 6.15 years); dividend of 0%; and volatility (48.4% – 66.1%).

Accretion of Redemption Premium

Our redeemable preferred stock is redeemable at the election of the majority of the preferred stock holders on or after December 31, 2012 if a qualified offering, defined as an initial public offering in which net proceeds from the sale of our common stock are $40 million or greater and the offering price per share is at least $20.78 (as adjusted for any stock dividends, combinations, or splits with respect to such shares), has not occurred. To the extent that redemption is requested, the holders will receive the greater of the fair value of the preferred stock at the time of redemption or the original issuance price. We record accretion related to this redemption premium, using the interest method, as an increase or decrease to the liquidation value of the redeemable preferred stock and a decrease or increase to additional paid-in capital based on the excess of the estimated fair value of each redeemable preferred stock over the stated minimum redemption price per share for each redeemable preferred stock over the period of time up to the redemption date. Upon completion of this offering, the redeemable preferred shares will convert to common shares and we will not record any further accretion.

Results of Operations

The following table sets forth our results of operations for the specified periods:

 

     Year Ended December 31,  
     2009     2010     2011  
     (in thousands)  
                    

Consolidated Statements of Operations Data:

      

Revenue:

      

Healthcare

   $ 70,718      $ 75,771      $ 90,917   

Commuter

     27,603        29,304        33,325   

Other

     10,140        9,972        11,395   
  

 

 

   

 

 

   

 

 

 

Total revenue

     108,461        115,047        135,637   
  

 

 

   

 

 

   

 

 

 

Operating expenses:

      

Cost of revenues (excluding amortization of internal use software)

     46,802        50,205        55,651   

Technology and development

     13,773        12,640        13,526   

Sales and marketing

     18,885        18,173        20,697   

General and administration

     20,134        18,231        20,876   

Amortization and change in contingent consideration

     8,398        7,764        11,327   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     107,992        107,013        122,077   
  

 

 

   

 

 

   

 

 

 

Income from operations

     469        8,034        13,560   

Other income (expense):

      

Interest income

     851        220        36   

Interest expense

     (1,102     (188     (494

Interest expense: amortization of convertible debt discount

     (71     (21,107     —     

Loss on extinguishment of debt

     (356     —          —     

Gain (loss) on revaluation of warrants

     70        (5,413     351   
  

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (139     (18,454     13,453   

Income tax (provision) benefit

     (495     1,204        19,868   
  

 

 

   

 

 

   

 

 

 

Net income (loss)

     (634     (17,250     33,321   

Accretion of redemption premium (expense) benefit

     1,037        (6,740     (6,209
  

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common stockholders

   $ 403      $ (23,990   $ 27,112   
  

 

 

   

 

 

   

 

 

 

 

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     Year Ended December 31,  
     2009     2010     2011  
                    

Consolidated Statements of Operations Data as a Percentage of Revenue:

      

Revenue:

      

Healthcare

     65     66     67

Commuter

     26        25        25   

Other

     9        9        8   
  

 

 

   

 

 

   

 

 

 

Total revenue

     100        100        100   
  

 

 

   

 

 

   

 

 

 

Operating expenses:

      

Cost of revenues (excluding amortization of internal use software)

     43        44        41   

Technology and development

     13        11        10   

Sales and marketing

     17        16        15   

General and administration

     19        16        16   

Amortization and change in contingent consideration

     8        6        8   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     100        93        90   
  

 

 

   

 

 

   

 

 

 

Income from operations

            7        10   

Other income (expense):

      

Interest income

     1                 

Interest expense

     (1              

Interest expense: amortization of convertible debt discount

            (18       

Loss on extinguishment of debt

                     

Gain (loss) on revaluation of warrants

            (5       
  

 

 

   

 

 

   

 

 

 

Loss before income taxes

            (16     10   

Income tax (provision) benefit

     (1     1        15   
  

 

 

   

 

 

   

 

 

 

Net income (loss)

     (1     (15     25   

Accretion of redemption premium (expense) benefit

     1        (6     (5
  

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common stockholders

         (21 )%      20
  

 

 

   

 

 

   

 

 

 

Comparison of the Years Ended December 31, 2009, 2010 and 2011

Revenue

 

     Year Ended December 31,      Change from Prior Year  
     2009      2010      2011      2010     2011  
     (in thousands)               

Revenue:

             

Healthcare

   $ 70,718       $ 75,771       $ 90,917         7     20

Commuter

     27,603         29,304         33,325         6        14   

Other

     10,140         9,972         11,395         (2     14   
  

 

 

    

 

 

    

 

 

      

Total revenue

   $ 108,461       $ 115,047       $ 135,637         6     18
  

 

 

    

 

 

    

 

 

      

Healthcare Revenue

The growth in healthcare revenue from 2010 to 2011 was primarily driven by the inclusion of a full year of post-purchase revenue of $4.4 million and $8.9 million for PBS and FBM, which were acquired in August 2010 and November 2010, respectively. Healthcare revenue also increased due to $1.2 million of increased revenue from SMB employer clients, which includes $0.5 million of increased Premium Only Plan kits revenue arising from the sale of self-service plan kits that we provide to employer clients to initiate the deduction of healthcare premiums on a tax deferred basis.

The growth in healthcare revenues from 2009 to 2010 was primarily driven by the inclusion of $1.8 million and $0.8 million in post-purchase revenues for PBS, which was acquired in August 2010, and FBM, which was

 

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acquired in November 2010. Interchange fees grew by $2.1 million due to an increased number of prepaid debit cards, both WageWorks-branded and those provided as part of our wholesale card program, and increased debit card usage as a percentage of overall employee participant spending.

Commuter Revenue

The growth in commuter revenue from 2010 to 2011 was primarily driven by an increased number of employee participants and the addition of a very large employer client in the first quarter of 2011. Commuter interchange revenue also increased by $0.9 million as a result of increased prepaid debit card usage.

The growth in commuter revenues from 2009 to 2010 was principally due to an increase in the number of employee participants from our existing employer clients as our portfolio purchases during this period had only a nominal amount of commuter revenue.

Other Revenue

The growth in other revenue from 2010 to 2011 was primarily driven by the inclusion of a full year of post-purchase COBRA revenue of $1.6 million and $1.4 million for PBS and FBM, respectively. These increases were offset, in part, by decreases in COBRA revenue, in part due to the loss of employee participants and, in part, due to the ending of the American Recovery and Reinvestment Act (ARRA), which provided a subsidy for COBRA benefits.

Cost of Revenues

 

     Year Ended December 31,     Change from Prior Year  
     2009     2010     2011     2010     2011  
     (in thousands)              

Cost of revenues (excluding amortization of internal use software)

   $ 46,802      $ 50,205      $ 55,651        7     11

Percent of revenue

     43     44     41    

The increase in cost of revenues (excluding amortization of internal use software) from 2010 to 2011 was primarily driven by the inclusion of a full year of post-purchase expenses for PBS and FBM of $10.4 million. These increases were offset, in part, by a $1.7 million decrease in costs as a result of substantially completing the integration of CB and a decrease in outsourced services expense of $0.8 million primarily related to savings from a negotiated reduction in rates with a third party vendor. In addition, payroll and related expenses and temporary worker expense decreased $1.1 million due to operations consolidation, the termination of ARRA and a decrease in depreciation expense of $0.5 million. The decrease in cost of revenues as a percentage of revenue was due to the significant increase in revenue and the cost reduction items discussed above.

The increase in cost of revenues (excluding amortization of internal use software) from 2009 to 2010 was primarily due to $1.4 million and $0.7 million relating to the post-purchase costs of PBS and FBM, respectively. In 2009, we had $1.1 million of net processing gains, due to the recovery of overpayments made in previous periods. In 2010, our net processing losses were $0.3 million.

In addition to these changes, headcount attributable to cost of revenues decreased by 7% in 2010, which contributed to a $0.7 million decrease in cost of revenues. The decrease in headcount was the result of the continued consolidation of operations between locations and an increase in outsourcing. The consolidation also reduced facilities costs by $0.4 million, while outsourcing costs increased by $0.5 million. Cost of revenues in 2009 benefited from a $0.3 million reduction in accrual for a third party claim. Cost of revenues as a percent of revenue increased due to the change from net processing gains in 2009 to net processing losses in 2010, despite higher revenue volume and other expense decreases.

 

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As we continue to scale our operations, we expect our cost of revenues to increase in dollar amount to support increased employer client and employee participant levels. Cost of revenues will continue to be affected by our portfolio purchases and our acquisition. Prior to migrating to our proprietary technology platforms, these new portfolios and acquisitions often operate with higher service delivery costs that result in increased cost of revenues until we are able to complete the migration process, which typically occurs over the 12- to 24-month period following closing of the portfolio purchase or acquisition. We expect our cost of revenues to increase in the first quarter of 2012 primarily as a result of our CS and TC transactions and also by approximately $0.2 million due to severance expenses incurred as a result of consolidation of certain operations.

Technology and Development

 

     Year Ended December 31,     Change from Prior Year  
     2009     2010     2011     2010     2011  
     (in thousands)              

Technology and development

   $ 13,773      $ 12,640      $ 13,526        (8 )%      7

Percent of revenue

     13     11     10    

The increase in technology and development expenses from 2010 to 2011 was primarily driven by an increase in salaries and personnel-related costs of approximately $1.5 million, an increase in outsourced services and temporary help and consulting services of $1.0 million related to the reporting capability and functionality of our platform and $0.9 million in Shared Services Agreement expenses paid to FBMC for support provided to certain acquired customer contracts. These increases were partially offset by a $2.3 million increase in the expenditures qualifying for capitalization in 2011 related to implementation of additional mobile features for our platform, mobile applications for our SMB client base as well as the development of functionality and integration of our COBRA platform. The decrease in technology and development expenses as a percentage of revenue was primarily due to the significant increase in revenue.

The decrease in technology and development expenses from 2009 to 2010 was primarily a result of a 13% reduction in headcount due to increased outsourcing and consolidation of our IT operations, which led to a decrease in personnel expenses of $0.6 million, excluding the effect of PBS and FBM which was a $0.1 million increase in personnel expenses. In addition, we incurred decreased use of our personnel and less outsourced programming on expensed development activities due to the completion of several significant customization and internal control projects during 2009. Technology and development expense as a percentage of revenue decreased due to these changes and increased revenue volume.

We intend to continue to enhance the functionality of our software platform as part of our continuous effort to improve our employer client and employee participant experience and to maintain and enhance our control and compliance environment. As a result of our focus on technology development and our CS and TC transactions, we expect our technology and development expenses to increase in dollar amount in future periods. The timing of development and enhancement projects, including whether they are in phases where costs are capitalized or expensed, will significantly affect our technology and development expense both in dollar amount and as a percentage of revenue.

Sales and Marketing

 

     Year Ended December 31,     Change from Prior Year  
     2009     2010     2011     2010     2011  
     (in thousands)              

Sales and marketing

   $ 18,885      $ 18,173      $ 20,697        (4 )%      14

Percent of revenue

     17     16     15    

The increase in sales and marketing expense from 2010 to 2011 was primarily driven by $2.5 million of additional expense arising from the acquisition of PBS and FBM. Excluding PBS and FBM, payroll and related expenses increased by approximately $0.8 million due to increased headcount associated with the growth of our business. These increases were partially offset by decreases of $0.4 million related to the completion of a public

 

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relations campaign and $0.2 million of advertising expense. The decrease in sales and marketing expense as a percentage of revenue was due to the significant increase in revenue.

The decrease in sales and marketing expense from 2009 to 2010 was primarily due to a 10% reduction in sales and marketing headcount, which reduced personnel expense by $2.1 million, excluding the effect of PBS and FBM which was a $0.2 million increase in personnel expenses. In April 2009, we reorganized in a number of areas to enable key personnel to focus solely on servicing either our healthcare or commuter programs. In addition, we reduced and reorganized our client services team to focus on specific regions. This decrease in personnel expenses was offset in part by expenses for increased promotional activity and education efforts focused on increasing employee participation levels in our tax-deferred CDBs among our existing employer client base. Sales and marketing expense as a percentage of revenue decreased slightly, primarily due to increased revenue volume.

We intend to continue to invest in sales, client services and marketing by hiring additional direct sales personnel and continuing to build our broker and channel relationships. We also intend to promote our brand through a variety of marketing and public relations activities. As a result of these factors and our CS and TC transactions, we expect our sales and marketing expenses to increase in dollar amount in future periods.

General and Administration

 

     Year Ended December 31,     Change from Prior Year  
     2009     2010     2011     2010     2011  
     (in thousands)              

General and administration

   $ 20,134      $ 18,231      $ 20,876        (9 )%      15

Percent of revenue

     19     16     16    

The increase in general and administrative expenses from 2010 to 2011 was primarily driven by an increase in payroll and related expenses, professional services expense and outsourced services expense aggregating approximately $3.3 million primarily due to our preparation to become a public company. These increases were partially offset by a $0.8 million decrease in temporary help and consulting services due to the completion of finance related infrastructure projects in 2010.

The decrease in general and administration expenses from 2009 to 2010 was primarily due to a decrease in consulting and accounting expenses of $1.0 million relating to the improvement of our controls and processes that we incurred in 2009 and to a decrease of $0.8 million in public service announcements and advocacy efforts that we incurred in 2009 relating to healthcare reform. General and administration expense as a percentage of revenues decreased due to these decreases together with increased revenue volume.

We expect our general and administrative expenses to increase in dollar amount in 2012 and beyond due to the increased expenses associated with our CS and TC transactions and expenses associated with being a public company. We also expect our general and administrative expenses to increase by approximately $0.2 million in the first quarter of 2012 due to severance and lease-related expenses incurred as a result of the consolidation of certain operations.

Amortization and Change in Contingent Consideration

 

     Year Ended December 31,      Change from Prior Year  
     2009      2010      2011      2010     2011  
     (in thousands)               

Amortization and change in contingent consideration

   $ 8,398       $ 7,764       $ 11,327         (8 )%      46

Our amortization consists of three components: amortization of internal use software, amortization of acquired intangibles and change in contingent consideration. We capitalize our software development costs related to the development and enhancement of our business solution. When the technology is available for its intended use, the capitalized costs are amortized over the technology’s estimated useful life, which is generally four years. Acquired intangibles are also amortized over their useful lives.

 

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The increase in amortization and change in contingent consideration from 2010 to 2011 was primarily due to charges of $1.4 million and $1.3 million, respectively, for contingent consideration related to our PBS and FBM portfolio purchases. These increases were driven by increases in revenue levels achieved and forecasted to be achieved in 2012. Amortization of acquired intangible assets increased $0.5 million due to the inclusion of a full year of post-purchase amortization of acquired intangible assets related to FBM and PBS.

The decrease in amortization from 2009 to 2010 was primarily a result of a decrease of $1.2 million in amortization of acquired intangible assets due to a number of acquired intangible assets becoming fully amortized in 2010. This decrease was partially offset by an increase in a $0.6 million amortization of internal use software as several major client specific platform enhancements and our daily settlement system were completed and amortization commenced, and increases in amortization related to the purchases of PBS and FBM of $0.2 million and $0.1 million, respectively. There was no change in contingent consideration in the years ended December 31, 2009 and 2010 as the acquisitions to which these contingent considerations relate occurred in the latter part of 2010.

We expect our amortization expenses to increase in 2012 and beyond due to the amortization of acquired intangibles associated with our CS and TC transactions in early 2012.

Other Income (Expense)

 

     Year Ended December 31,  
     2009     2010     2011  
     (in thousands)  

Interest income

   $ 851      $ 220      $ 36   

Interest expense

     (1,102     (188     (494

Interest expense: amortization of convertible debt discount

     (71     (21,107     —     

The decrease in interest income from 2009 through 2011 was due to reduced short-term interest rates available to us on our invested funds.

The increase in interest expense from 2010 to 2011 was primarily due to the increase in the outstanding amount borrowed under our credit facility with Union Bank, N.A. in 2011 as compared to 2010.

The decrease in interest expense from 2009 to 2010 was primarily due to the repayment of a debt facility in December 2009.

The absence of amortization of convertible debt discount in 2011 is due to the full amortization of the convertible notes in 2010 and the conversion of the notes to equity in July 2010.

Our convertible notes issued on December 28, 2009 resulted in a debt discount of $20.0 million. We amortized as interest $11.4 million of the debt discount from January 1, 2010 to the date of the conversion of the notes and accrued interest of $1.2 million on July 31, 2010. At the conversion date, the remaining unamortized debt discount balance of $8.5 million was immediately expensed as interest.

Revaluation of Warrants

 

     Year Ended December 31,  
     2009      2010     2011  
     (in thousands)  

Gain (loss) on revaluation of warrants

   $ 70       $ (5,413   $ 351   

The mark-to-market adjustment related to our outstanding warrants for Series C redeemable preferred stock was a $0.4 million gain for the year ended December 31, 2011 primarily due to a decline in the underlying fair market value of our Series C redeemable preferred stock.

 

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The significant increase in expense relating to revaluation of warrants in 2010 relative to 2009 is primarily due to the mark-to-market adjustment of Series E redeemable preferred stock warrants issued to the holders of our convertible debt on December 28, 2009. This mark-to-market adjustment was required as a result of the warrants being classified as a liability because the Series E preferred shares were redeemable. In July 2010, the warrants were amended to provide that, upon exercise, the holders would receive shares of our Series E-1 preferred stock which are not redeemable. For that reason, the warrants were reclassified from a liability to equity and mark-to-market adjustments were no longer required. The total mark-to-market adjustment for these warrants was approximately $5.0 million for 2010.

Mark-to-market adjustments related to our outstanding warrants for Series C redeemable preferred stock will continue until these warrants expire or are exercised. Upon the completion of this offering, the warrants for Series C redeemable preferred stock will either be exercised for shares of common stock or converted to warrants to purchase common stock. At that time, we will no longer record any mark-to-market changes in the fair value of these warrants in our statement of operations. The total mark-to-market adjustment for these warrants was approximately $0.4 million for 2010.

Income Taxes

 

     Year Ended December 31,  
     2009     2010      2011  
     (in thousands)  

Income tax (provision) benefit

   $ (495   $ 1,204       $ 19,868   

The change from 2010 to 2011 is primarily related to the release of the $25.9 million valuation allowance at December 31, 2011. In the fourth quarter of 2011, we determined, based on our recent history of taxable income coupled with our forecasted profitability and enrollments that occurred in the fourth quarter that continued to show growth and stability in the number of employee participants enrolling and being retained, that it is more likely than not that the deferred tax assets as of December 31, 2011 will be realized in the foreseeable future and a valuation allowance should no longer be maintained against the remaining deferred tax assets. Such determination was based upon the realization of taxable income in 2011 and our projection of future taxable income.

The change in income taxes from 2009 to 2010 is due to our purchase of PBS in August 2010 in which we recorded a deferred tax liability related to the book and tax bases differences in our purchase accounting. This increase in deferred tax liabilities resulted in a reduction of our valuation allowance for net deferred tax assets which is recorded as an income tax benefit in our statement of operations.

The expenses in 2009 primarily reflect the recording of deferred tax liabilities due to the book and tax bases differences related to the goodwill acquired in certain of our portfolio purchases.

Accretion of Redemption Premium

 

     Year Ended December 31,  
     2009      2010     2011  
     (in thousands)  

Accretion of redemption premium (expense) benefit

   $ 1,037       $ (6,740   $ (6,209

Certain of our series of preferred stock are redeemable after December 31, 2012 at the election of the majority of the holders of those series if we have not completed an initial public offering by December 31, 2012. To the extent that the redemption is requested, the holders will receive the greater of the fair value of the preferred stock at the time of redemption and the original purchase price. We account for this redemption premium by recording accretion charges reflecting the changes in the redemption value over the period from the date of issuance to the earliest redemption date, which is December 31, 2012.

 

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The significant increases in accretion of redemption premium expense in 2010 and 2011, relative to 2009, relate to the issuance of shares of Series E preferred stock in July 2010 that provide for the same type of redemption premium as well as an increase in the fair value of our preferred stock based on our performance and that of the general economy. The benefit in 2009 arises from a decrease in the value of shares of our preferred stock from 2008 to 2009 arising from general economic conditions.

Quarterly Results of Operations

The following table sets forth our unaudited quarterly condensed consolidated statements of operations data for each of the eight quarters ended December 31, 2011. The data has been prepared on the same basis as the audited consolidated financial statements and related notes included in this prospectus and you should read the following tables together with such financial statements. The quarterly results of operations include all normal recurring adjustments necessary for a fair presentation of this data. Results of interim periods are not necessarily indicative of results for the entire year and are not necessarily indicative of future results.

 

    Quarter Ended  
    March 31,
2010
    June 30,
2010
    September 30,
2010
    December 31,
2010
    March 31,
2011
    June 30,
2011
    September 30,
2011
    December 31,
2011
 
    (in thousands, unaudited)  

Condensed Consolidated Statements of Operations Data:

               

Revenue:

               

Healthcare

  $ 20,017      $ 18,249      $ 17,733      $ 19,772      $ 24,225      $ 22,854      $ 21,511      $ 22,327   

Commuter

    7,142        7,350        7,288        7,524        8,207        8,382        8,271        8,465   

Other

    2,553        2,208        2,312        2,899        2,892        2,625        2,665        3,213   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    29,712        27,807        27,333        30,195        35,324        33,861        32,447        34,005   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenues (excluding amortization of internal use software)

    13,297        11,747        11,336        13,825        15,366        13,244        12,537        14,504   

Technology and development

    3,557        3,051        2,966        3,066        3,492        3,447        3,403        3,184   

Sales and marketing

    4,628        4,325        4,942        4,278        5,249        5,209        4,733        5,506   

General and administration

    5,423        4,150        4,249        4,409        5,362        5,104        5,163        5,247   

Amortization and change in contingent consideration

    1,912        1,878        1,900        2,074        2,493        2,682        2,985        3,167   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    28,817        25,151        25,393        27,652        31,962        29,686        28,821        31,608   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

    895        2,656        1,940        2,543        3,362        4,175        3,626        2,397   

Other income (expense):

               

Interest income

    107        71        27        15        11        9        7        9   

Interest expense

    (42     (3     (19     (124     (86     (111     (125     (172

Interest expense: amortization of convertible debt discount

    (5,358     (5,418     (10,331     —          —       

 

—  

  

 

 

—  

  

    —     

Gain (loss) on revaluation of warrants

    (5,935     (9,606     10,642        (514     (110     51        627        (217
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (10,333     (12,300     2,259        1,920        3,177        4,124        4,135        2,017   

Income tax (provision) benefit

    (195     (283     1,582        100        (148     (253     (234     20,503   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (10,528     (12,583     3,841        2,020        3,029        3,871        3,901        22,520   

Accretion of redemption premium (expense) benefit

    (70     (70     (3,094     (3,506     (2,768     (2,924     387        (904
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common stockholders

  $ (10,598   $ (12,653   $ 747      $ (1,486   $ 261      $ 947      $ 4,288      $ 21,616   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    Quarter Ended  
    March 31,
2010
    June 30,
2010
    September 30,
2010
    December 31,
2010
    March 31,
2011
    June 30,
2011
    September 30,
2011
    December 31,
2011
 
    (unaudited)  

Condensed Consolidated Statements of Operations Data as a Percentage of Revenue:

               

Revenue:

               

Healthcare

    67     66     65     65     69     67     66     66

Commuter

    24        26        27        25        23        25        26        25   

Other

    9        8        8        10        8        8        8        9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    100        100        100        100        100        100        100        100   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenues (excluding amortization of internal use software)

    45        42        41        46        43        39        39        43   

Technology and development

    12        11        11        10        10        10        10        9   

Sales and marketing

    16        15        18        14        15        16        15        16   

General and administration

    18        15        16        15        15        15        16        16   

Amortization and change in contingent consideration

    6        7        7        7        7        8        9        9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    97        90        93        92        90        88        89        93   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

    3        10        7        8        10        12        11        7   

Other income (expense):

               

Interest income

    —          —          —          —          —          —          —          —     

Interest expense

    —          —          —          —          —          —          —          —     

Interest expense: amortization of convertible debt discount

    (18     (19     (38     —          —          —          —          —     

Gain (loss) on revaluation of warrants

    (20     (35     39        (2     —          —          2        (1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (35     (44     8        6        10        12        13        6   

Income tax (provision) benefit

    (1     (1     6        —          (1     (1     (1     60   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (36     (45     14        6        9        11        12        66   

Accretion of redemption premium (expense) benefit

    —          —          (11     (11     (8     (8     1        (2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common stockholders

    (36 )%      (45 )%      3     (5 )%      1     3     13     64
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Changes in healthcare revenue reflect the seasonality of this portion of our business. The first quarter is expected to provide increased revenues because we continue to bill employer clients for employee participants who terminate their enrollment for the new plan year, but who still participate in the run-out or grace period of the old plan year that normally runs through the first quarter of the new plan year. Interchange revenue also typically increases during the first quarter due to employee participants who utilize their account balances for the new plan year and other employee participants who are spending any remaining account balances they may have under the old plan year during the grace period. The declining trend of healthcare revenue over the second and third quarters is partially attributable to a gradual decrease in interchange revenue as employee participants begin to slow their spending as the year progresses, subject to a small increase in activity in December as some employee participants spend the remainder of their account balance prior to the end of the year. In addition, during the late third and fourth quarters, we have an increase in our revenue from sales of a self-service plan kit that we provide employer clients to initiate the deduction of healthcare premiums on a tax deferred basis, without the use of a spending account, which we refer to as our Premium Only Plan. Our quarterly revenue can also be impacted by the timing of our portfolio purchases.

Employees may elect to participate in our commuter programs at any time during the year. In the past, we have experienced some seasonality in this portion of our business because participation rates typically slow during the summer as employee participants take vacations and do not purchase transit passes or parking through us during that time period.

 

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Other services revenues, which consist of COBRA and enrollment and eligibility fees, are generally consistent throughout the year but may increase in the fourth quarter due to additional enrollment and eligibility fees being earned after our clients’ open enrollment seasons.

Quarterly revenue in 2010 was impacted by $0.5 million from PBS in the third quarter of 2010 and an incremental $1.1 million and $1.0 million from PBS and FBM, respectively, in the fourth quarter of 2010, which accounted for part of the increase during this period. In addition, Premium Only Plan, or POP, revenue increased by $0.7 million from the third quarter of 2010 to the fourth quarter of 2010. In the first quarter of 2011, as compared to the fourth quarter of 2010, quarterly revenue was impacted by $1.9 million of additional revenue from FBM which reflects the full quarter compared to one month of revenue in the fourth quarter. First quarter 2011 revenue also reflects an increase in commuter participants and the seasonal increase in healthcare activity associated with the new plan year and run-out grace periods for the 2010 plan year when compared to the second quarter of 2011. POP revenue increased by $1.0 million from the third quarter of 2011 to the fourth quarter of 2011, which reflects the seasonality of this revenue and is consistent with 2010.

Cost of revenues (excluding amortization of internal use software) typically varies based on our revenue and is, therefore, impacted by the seasonality of the business. We incur higher expenses in the first quarter associated with increased headcount in the form of temporary workers, consultants and other outsourced services that are required to cover the increased call volume and activity associated with the new plan year. The need for these resources diminishes in the second and third quarters, but increases again in the fourth quarter when we provide services to our employer clients during their open enrollment periods. The fourth quarter also reflects expenses that relate to the sale of our Premium Only Plan kits and the production of debit cards. In addition, our quarterly revenue can also be impacted by the timing of our portfolio purchases. Portfolio purchases may have a short-term material adverse impact on our results of operations, including a potential material adverse impact on our cost of revenues as we seek to migrate acquired employer clients to our proprietary technology platforms, typically over the succeeding 12 to 24 months, in order to achieve additional operating efficiencies.

The fourth quarter of 2010 and first quarter of 2011 reflect additional cost of revenues of $1.4 million and $1.6 million, due to the purchases of PBS and FBM, respectively. Cost of revenues (excluding amortization of internal use software) for the first quarter of 2011 also increased in dollar amount due to the seasonal increases in our customer service center costs when compared to the second quarter of 2011 but decreased as a percentage of revenue as a result of our increased sales revenues. In the second quarter of 2011, there was a decrease of $1.0 million in outsourced services expenses. Of the $1.0 million decrease, $0.5 million relates to savings for the first quarter of 2011 as a result of completion of the re-negotiation of a services agreement effective January 1, 2011. The decrease in cost of revenues from the second quarter of 2011 to the third quarter of 2011 was primarily caused by our continued efforts to consolidate operations and the seasonality of our business. Cost of revenues for the fourth quarter of 2011 increased in dollar amount due to increased outsourced services that are required to cover higher call volume during open enrollment and expenses that relate to the sale of our Premium Only Plan kits and the production of debit cards.

Technology and development expense is most significantly affected by changes in the stage of development of our internal use software, which determines whether amounts spent are capitalized or expensed.

Sales and marketing expense generally varies from quarter to quarter based on when we undertake promotion activities and when sales commissions are earned. For example, sales and marketing expenses increased in the third quarter of 2010 because we invested in a promotional campaign to increase awareness of pre-tax CDB accounts. Sales commission expense increased in the first quarter of 2011 relative to the fourth quarter of 2010 as the 2010 sales plan year closed out and the new sales plan year commenced. Additionally, we hired new enterprise sales representatives. Sales and marketing expense increased in the fourth quarter of 2011 relative to the third quarter of 2011 due to the commencement of a six-month pilot sales program to increase market awareness for our commuter program.

 

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General and administration expense varies from quarter-to-quarter based on the timing of expenses for accounting. For example, our accounting and consulting fees were higher in the first quarter of 2010 as a result of conducting our annual audit. Our expenses related to our preparation to become a publicly held company increased in the third and fourth quarters of 2010 because we commenced activities to file a registration statement for this offering. In the first quarter of 2011, payroll and related expenses increased by $0.7 million relative to the fourth quarter of 2010 as we increased our bonus expense accrual based on our 2011 forecast and filled several open positions. The first quarter of 2011 also reflects the expenses associated with our annual audit for 2010.

Amortization and change in contingent consideration increased by $0.3 million from the second quarter of 2011 to the third quarter of 2011 and by $0.2 million from the third quarter of 2011 to the fourth quarter of 2011 due to increased contingent consideration for our PBS and FBM portfolio purchases.

Amortization of convertible debt discount terminated in the third quarter of 2010 when our convertible notes were converted into preferred stock. Gain (loss) on revaluation of warrants for our Series E preferred stock terminated in the third quarter when the warrants were reclassified from debt to equity and were no longer subject to mark-to-market changes. Our Series C preferred stock warrants continue to be marked-to-market.

Income tax (provision) benefit in the fourth quarter of 2011 reflects the release of the $25.9 million valuation allowance. In the fourth quarter of 2011, we determined, based on our recent history of taxable income coupled with our forecasted profitability and enrollments that occurred in the fourth quarter that continued to show growth and stability in the number of employee participants enrolling and being retained, that it is more likely than not that the deferred tax assets will be realized in the foreseeable future and a valuation allowance should no longer be maintained.

Liquidity and Capital Resources

At December 31, 2011, our principal sources of liquidity were cash and cash equivalents totaling $154.6 million comprised primarily of prefunds by clients of amounts to be paid on behalf of employee participants as well as, in recent years, other cash flows from operating activities. To date, our operations have been financed primarily through cash flows from operating activities, the sale of preferred stock and short and long-term borrowings. Since inception, we have raised $135.8 million of equity capital and at December 31, 2011, we had debt with a principal amount of $15.0 million outstanding. Subsequent to December 31, 2011, we completed the CS and TC transactions and drew down $29.6 million under the credit facility with Union Bank, N.A., or UB. For a discussion of the details of the amendment to our credit facility with UB, see “—Union Bank Credit Facility” below.

We believe that our existing cash and cash equivalents, combined with our credit facility, expected cash flow from operations, and net proceeds of this offering will be sufficient to meet our operating and capital requirements, as well as anticipated cash requirements for potential future portfolio purchases, over at least the next 12 months. At December 31, 2011, our current liabilities exceeded our current assets by $35.8 million. However, we have historically been able to fulfill our obligations as incurred and expect to continue to fulfill our obligations in the future. Our expectation is based not only on receipt of the proceeds of this offering but also on our current and anticipated client retention rates and our continuing funding model in which the vast majority of our enterprise clients provide us with prefunds as more fully described below under “—Prefunds.” To the extent these current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, including any potential portfolio purchases, we may need to raise additional funds through public or private equity or debt financing. We cannot provide assurance that we will be able to raise additional funds on favorable terms, if at all.

Prefunds

Under our contracts with the vast majority of our enterprise employer clients, we receive prefunds that have been and are expected to continue to be a significant source of cash flows from operating activities. Each prefund is reflected in cash and cash equivalents on our balance sheet with an equivalent customer obligation recorded as a liability as the prefund is received. Changes in these prefunds and corresponding customer obligations are reflected in our cash flows from operating activities. The substantial majority of our SMB employer clients

 

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deposit funds into a separate custodial account, and those funds are neither a source of cash flows from operating activities nor reflected on our balance sheet. These SMB employer clients are responsible for maintaining an adequate balance in those custodial accounts to cover their employee participants’ claims. We only pay SMB employee participant claims from amounts in the custodial accounts.

The operation of these prefunds for our enterprise employer clients throughout the year typically is as follows: at the beginning of a plan year, these employer clients provide us with prefunds for their FSA and HRA programs based on a percentage of projected spending by the employee participants for the plan year. In the case of our commuter program, at the beginning of each month we receive prefunds based on the employee participants’ monthly elections. These prefunds are typically replenished on a weekly basis by our FSA and HRA employer clients and on a monthly basis by our commuter employer clients, in each case, after we have advanced the funds necessary to process employee participants’ FSA and HRA claims as they are submitted to us and to pay vendors relating to our commuter programs. As a result, our cash balances can vary significantly depending upon the timing of invoicing of, and payment by, our employer clients of reimbursement for payments we have made on behalf of employee participants. This prefunding activity covers our estimate of approximately one week of spending on behalf of the employer client’s employee participants. We do not require a prefund to administer any of our HSA programs because employee participants in these programs only have access to funds they have previously contributed.

By way of example, a new FSA enterprise employer client with a plan year starting January 1 will typically provide between 4-6% of the projected annual election for its employee participants as a prefund. In this example, we would typically receive this prefunding in late December. Once the new plan year starts, the employee participants can immediately access all elected funds of their FSA benefit even before any payroll deductions have commenced. This access to funds differs from our HSA programs where available funds are added to employee participants’ accounts only as payroll deductions occur and HRA programs where funds are only available as contributions are made.

Following the run-out period and grace period, the FSA prefunds from the prior plan year are reconciled and funds are returned to the employer clients, resulting in a substantial decline in our cash position. The cycle then repeats itself in each plan year as participants enroll in programs and prefunds are received in the fourth quarter for the new plan year. In a majority of cases, new FSA prefunds for the succeeding plan year are received prior to a plan year’s prefund being fully paid out in the form of benefits for employee participants or being returned to the employer client. Because participant activity in our commuter programs varies monthly, prefunds for these programs fluctuate monthly.

Our enterprise client contracts do not contain restrictions on our use of enterprise client prefunds and, as a result, these prefunds are reflected as cash and cash equivalents on our balance sheet and changes in prefunds are recorded as an element of our cash flow from operating activities. The timing of when employer clients make their prefunds as well as the timing of when we make payments on behalf of employee participants can significantly affect our cash flows.

Union Bank Credit Facility

In November 2011, we entered into an amendment to our loan agreement with UB to increase the aggregate principal amount that could be borrowed to $50.0 million from $15.0 million. Each loan under the credit facility bears interest at a variable rate of the prime rate plus 0.5% or, at our option, a fixed interest rate equal to the LIBOR rate for a period of either one, two, three or six months, if offered by UB, plus 3.0%. At December 31, 2011, we had outstanding indebtedness of $15.0 million under the credit facility at interest rates ranging from 3.42% to 3.54%. In January 2012, we drew down $29.6 million under the credit facility to finance the TC acquisition and used $5.4 million to collateralize a letter of credit for the related contingent payment. Upon successful completion of this offering, the due date will be automatically extended to October 31, 2013 from the current due date of October 31, 2012.

 

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Loans under the credit facility that bear interest at the prime rate may be prepaid by us, in whole or in part, without penalty or premium. Loans that bear interest at LIBOR rates may only be prepaid upon five business days’ notice to UB and subject to a prepayment fee equal to the present value of the difference between the return that UB could obtain if it used the amount of such prepayment of principal to purchase regularly quoted securities issued by the United States at bid price, and the return UB would have received had the prepayment not been made.

To maintain availability of funds under the credit facility, we pay UB a commitment fee on the unused portion of the credit facility. The commitment fee is equal to 0.25% of the unused portion per annum and is recorded as interest expense.

As part of our credit facility with UB, we are required to maintain certain covenants including financial covenants relating to a quick ratio, monthly minimum 3-month EBITDA coverage and a monthly cash flow coverage ratio. We are currently in compliance with all financial covenants under our credit facility. The credit facility contains customary events of default, subject to customary cure periods for certain defaults. Upon an event of default, all amounts outstanding under the credit facility will become immediately due and payable.

Cash Flows

The following table presents information regarding our cash flows, cash and cash equivalents in 2009, 2010 and 2011:

 

     Year Ended December 31,  
     2009     2010     2011  
     (in thousands)  

Net cash provided by operating activities

   $ 31,075      $ 20,476      $ 55,189   

Net cash used in investing activities

     (9,253     (12,299     (12,594

Net cash (used in) provided by financing activities

     (663     2,842        7,746   
  

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

     21,159        11,019        50,341   

Cash and cash equivalents, end of period

   $ 93,261      $ 104,280      $ 154,621   

Cash Flows from Operating Activities

 

     Year Ended December 31,  
     2009      2010      2011  
     (in thousands)  

Net cash provided by operating activities

   $ 31,075       $ 20,476       $ 55,189   

Net cash provided by operating activities in 2011 resulted primarily from our net income of $33.3 million being adjusted for the following non-cash items: depreciation, amortization and change in contingent consideration aggregating $14.5 million and stock-based compensation of $2.2 million offset by a $20.2 million increase in deferred tax assets, primarily as a result of releasing the valuation allowance. Cash from operating activities was further increased by $28.9 million of customer obligations primarily due to the increase in our commuter elections, an increase in prefunds and the timing of our billings and employer client payments. These cash flows were offset in part by a $4.0 million increase in prepaid expenses and other current assets, primarily due to prepaid expenses related to our public offering.

Net cash provided by operating activities in 2010 resulted primarily from our net loss of $17.3 million being adjusted for the following non-cash items: amortization of convertible debt discount of $21.1 million, depreciation and amortization of $11.9 million, change in the fair value of our Series C and Series E-1 warrants of $5.4 million and stock-based compensation of $2.4 million. We also experienced a $1.5 million increase in prefunds due to the timing of our billings and employer client payments as discussed in “Liquidity and Capital Resources—Prefunds.” These cash flows were offset in part by a $1.3 million change in deferred taxes primarily related to our PBS acquisition and a $2.1 million increase in accounts receivable attributable to our increased revenue volume.

 

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Net cash provided by operating activities in 2009 resulted in part from our net loss of $0.6 million being adjusted for the following non-cash items: depreciation and amortization of $13.0 million and stock-based compensation of $2.5 million. We also experienced a $12.9 million increase in customer obligations which was principally the result of an increase in the size of employee participants’ commuter elections and commuter prefunds, a portion of which was the direct result of pre-tax transit limits being almost doubled in 2009 as compared to 2008, and a $2.4 million decrease in accounts receivable attributable to improved collections.

Cash Flows from Investing Activities

 

     Year Ended December 31,  
     2009     2010     2011  
     (in thousands)  

Net cash used in investing activities

   $ (9,253   $ (12,299   $ (12,594

Net cash used in investing activities consists primarily of our investment in internal use software that is capitalized prior to it being available for its intended use, capital expenditures and purchases of portfolios.

Net cash used in investing activities in 2011 was primarily a result of $9.4 million of capitalized internal use software and purchased equipment principally related to enhancing the functionality of our platform and a $1.9 million cash payment, net of cash received, made in connection with our FBM portfolio purchase. We also used cash to increase our restricted cash by $1.3 million, in preparation for our CS portfolio purchase on January 3, 2012.

Net cash used in investing activities in 2010 was primarily a result of $7.3 million of capitalized internal use software and purchased equipment, which was largely related to further upgrades to our product platform and control environment. Some of our major projects for the year included the implementation of mobile features for our platform, such as our mobile application for use on Apple iPhone® and iPad® devices, the final stage of the daily settlement system implementation, increased automation for our COBRA services and significant platform changes to accommodate unique client requirements. We also used $5.0 million of cash, net of cash received, for payments made in connection with the purchases of CB, PBS and FBM.

Net cash used in investing activities in 2009 was principally due to $6.6 million of capitalized internal use software and purchased equipment, which was largely related to our continued upgrades to our product platform and control environment. We used $2.1 million of cash for a contingent payment made in connection with the purchase of CB. We also used $0.6 million of cash to increase our restricted cash due to an increase in a cash secured letter of credit for one of our commuter employer clients as a result of increased employee participation.

Cash Flows from Financing Activities

 

     Year Ended December 31,  
     2009     2010      2011  
     (in thousands)  

Net cash (used in) provided by financing activities

   $ (663   $ 2,842       $ 7,746   

Net cash provided by financing activities in 2011 was due to $12.1 million in draw downs on our credit facility to fund payments related to our contingent consideration payments for FBM and PBS portfolio purchases that took place in 2010, partially offset by the FBM contingent consideration payment of $2.3 million and the PBS contingent consideration payment of $2.0 million.

Net cash provided in financing activities in 2010 was due to drawing down on our credit facility to fund our acquisition of PBS. Net cash used in financing activities in 2009 reflected payments on capital leases on service delivery equipment and our purchase of treasury stock from a stockholder.

 

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Recent Accounting Pronouncements

In December 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-11, Disclosures about Offsetting Assets and Liabilities, which created new disclosure requirements about the nature of an entity’s rights of offset and related arrangements associated with its financial instruments and derivative instruments. The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods therein, with retrospective application required. The adoption of ASU 2011-11 may have an impact on us as to financial disclosure but will not have a material impact on our financial position or results of operations.

In September 2011, the FASB issued Accounting Standards Update, or ASU 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The guidance in ASU 2011-08 is intended to reduce complexity and costs by allowing an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. The amendments also improve previous guidance by expanding upon the examples of events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Also, the amendments improve the examples of events and circumstances that an entity having a reporting unit with a zero or negative carrying amount should consider in determining whether to measure an impairment loss, if any, under the second step of the goodwill impairment test. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The adoption of ASU 2011-08 is not expected to have a material impact on our financial position or results of operations.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which is effective for annual reporting periods beginning after December 15, 2011. This guidance amends certain accounting and disclosure requirements related to fair value measurements. Additional disclosure requirements in the update include: (1) for Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (2) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use, the reason for the difference; (3) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (4) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. The adoption of ASU 2011-04 will not have a material impact on our financial position or results of operations.

Contractual Obligations

The following table describes our contractual obligations as of December 31, 2011:

 

     Total      Less than
1 Year
     1-3 Years      4-5 Years      More than
5 Years
 

Long term debt obligations(1)

   $ 15,000       $ 15,000       $ —         $ —         $ —     

Interest on long-term debt obligations(2)

     522         522         —           —           —     

Operating lease obligations(3)

     11,837         4,551         7,286         —           —     

Acquisition payments(4)

     10,022         10,022         —           —         &nbs