0001158863-19-000014.txt : 20190318 0001158863-19-000014.hdr.sgml : 20190318 20190318163202 ACCESSION NUMBER: 0001158863-19-000014 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 78 CONFORMED PERIOD OF REPORT: 20180331 FILED AS OF DATE: 20190318 DATE AS OF CHANGE: 20190318 FILER: COMPANY DATA: COMPANY CONFORMED NAME: WAGEWORKS, INC. CENTRAL INDEX KEY: 0001158863 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 943351864 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-35232 FILM NUMBER: 19688658 BUSINESS ADDRESS: STREET 1: 1100 PARK PLACE STREET 2: 4TH FLOOR CITY: SAN MATEO STATE: CA ZIP: 94403 BUSINESS PHONE: 650-557-5200 MAIL ADDRESS: STREET 1: 1100 PARK PLACE STREET 2: 4TH FLOOR CITY: SAN MATEO STATE: CA ZIP: 94403 FORMER COMPANY: FORMER CONFORMED NAME: WAGEWORKS INC DATE OF NAME CHANGE: 20010907 10-Q 1 wage-q12018x10q.htm 10-Q Document
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________________________
FORM 10-Q
__________________________________________________________
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from____________   to  ____________

Commission File Number: 001-35232
__________________________________________________________
WAGEWORKS, INC.
(Exact name of Registrant as specified in its charter)
__________________________________________________________
Delaware
 
94-3351864
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
໿
 
1100 Park Place, 4th Floor
San Mateo, California 94403
(Address of principal executive offices, including zip code)
 

(650) 577-5200
(Registrant’s telephone number, including area code)
________________________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  [ ]     No  [X]

Indicate by check mark whether the registrant has submitted electronically and posted to its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  [ ]     No  [X]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
[X]
 
Accelerated filer
[ ]
Non-accelerated filer
[ ]
  (Do not check if a smaller reporting company)
Smaller reporting company
[ ]
 
 
 
Emerging growth company
[ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐    

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  [ ]    No  [X]

As of March 14, 2019, there were 39,852,857 shares of the registrant’s common stock outstanding.
 



WAGEWORKS, INC.
FORM 10-Q QUARTERLY REPORT
Table of Contents

 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




2


PART I.     FINANCIAL INFORMATION

Item 1. Financial Statements

WAGEWORKS, INC.
Condensed Consolidated Balance Sheets
(In thousands, except per share amounts)
 
March 31, 2018
 
December 31, 2017
 
(Unaudited)
 
Derived from
Audited Financial
Statements
Assets
 
 
 
Current assets:
 
 
 

Cash and cash equivalents
$
691,341

 
$
779,345

Restricted cash
332

 
332

Short-term investments
259,989

 
195,534

Receivables, net
126,216

 
107,547

Prepaid expenses and other current assets
25,772

 
29,271

Total current assets
1,103,650

 
1,112,029

Property and equipment, net
71,529

 
68,742

Goodwill
297,409

 
297,409

Acquired intangible assets, net
149,078

 
155,369

Deferred tax assets, net
8,027

 
10,143

Other assets
23,070

 
8,291

Total assets
$
1,652,763

 
$
1,651,983

Liabilities and Stockholders' Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued expenses
$
96,316

 
$
89,977

Customer obligations
659,602

 
695,368

Other current liabilities
3,310

 
628

Total current liabilities
759,228

 
785,973

Long-term debt, net of financing cost
245,035

 
244,915

Other non-current liabilities
9,540

 
8,845

Total liabilities
1,013,803

 
1,039,733

Commitments and Contingencies (Note 14)

 

Stockholders' Equity:
 
 
 
Common stock, par value $0.001 per share (authorized 1,000,000 shares; 40,333 shares issued and 39,853 shares outstanding at March 31, 2018 and 40,251 shares issued and 39,771 shares outstanding at December 31, 2017)
41

 
41

Additional paid-in capital
571,598

 
562,131

Treasury stock at cost (480 shares at March 31, 2018 and December 31, 2017)
(22,309
)
 
(22,309
)
Accumulated other comprehensive loss
(1,085
)
 
(354
)
Retained earnings
90,715

 
72,741

Total stockholders’ equity
638,960

 
612,250

Total liabilities and stockholders’ equity
$
1,652,763

 
$
1,651,983


See accompanying notes to the condensed consolidated financial statements.

3


WAGEWORKS, INC.
Condensed Consolidated Statements of Income
(In thousands, except per share amounts)
(Unaudited)
 
Three Months Ended March 31,
 
2018
 
2017
Revenues:
 
 
 
Healthcare
$
75,256

 
$
74,674

COBRA
28,835

 
28,550

Commuter
18,878

 
18,543

Other
3,671

 
4,270

Total revenues
126,640

 
126,037

Operating expenses:
 
 
 
Cost of revenues (excluding amortization of internal use software)
45,242

 
48,088

Technology and development 
13,033

 
15,271

Sales and marketing 
18,338

 
16,079

General and administrative 
25,249

 
13,500

Amortization
9,991

 
9,237

Employee termination and other charges

 
731

Total operating expenses
111,853

 
102,906

Income from operations
14,787

 
23,131

Other income (expense):
 
 
 
Interest income
1,271

 
67

Interest expense
(2,182
)
 
(1,436
)
Other income (expense), net
(5
)
 
(221
)
Income before income taxes
13,871

 
21,541

Income tax provision
(2,852
)
 
(5,484
)
Net income
$
11,019

 
$
16,057

Net income per share:
 
 
 
Basic
$
0.28

 
$
0.43

Diluted
$
0.27

 
$
0.42

Shares used in computing net income per share:
 
 
 
Basic
39,823

 
37,025

Diluted
40,480

 
38,441


See accompanying notes to the condensed consolidated financial statements.

4


WAGEWORKS, INC.
Condensed Consolidated Statements of Comprehensive Income
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2018
 
2017
Net income
$
11,019

 
$
16,057

Other comprehensive income (loss), net of tax:
 
 
 
Net unrealized loss on short-term investments, net of tax
(730
)
 

Other comprehensive loss, net of tax
(730
)
 

Total comprehensive income
$
10,289

 
$
16,057



See accompanying notes to the condensed consolidated financial statements.


5


WAGEWORKS, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
11,019

 
$
16,057

Adjustments to reconcile net income to net cash used in operating activities:
 
 

Depreciation
3,191

 
2,568

Amortization
9,991

 
9,236

Amortization of debt issuance costs
120

 
47

Amortization of commissions
(780
)
 

Stock-based compensation expense
7,293

 
3,780

Loss on disposal of fixed assets
18

 
72

Provision for doubtful accounts
19

 
346

Deferred taxes
1

 
593

Other
(20
)
 

Changes in operating assets and liabilities:
 
 

Receivables
(18,688
)
 
(61,918
)
Prepaid expenses and other current assets
7,160

 
4,854

Other assets
(8,341
)
 
3,017

Accounts payable and accrued expenses
5,480

 
23,194

Customer obligations
(35,766
)
 
(57,375
)
Other liabilities
2,429

 
1,738

Net cash used in operating activities
(16,874
)
 
(53,791
)
Cash flows from investing activities:
 
 

Purchases of property and equipment
(7,618
)
 
(5,576
)
Cash paid for acquisition of intangible assets

 
(397
)
Purchases of short-term investments
(99,564
)
 

Proceeds from maturities of short-term investments
34,150

 

Purchases of intangible assets
(70
)
 

Net cash used in investing activities
(73,102
)
 
(5,973
)
Cash flows from financing activities:
 
 

Proceeds from exercise of common stock options
1,396

 
4,071

Proceeds from issuance of common stock under Employee Stock Purchase Plan
869

 
769

Payments of debt principal

 
(2,500
)
Taxes paid related to net share settlement of stock-based compensation arrangements
(218
)
 
(4,684
)
Payment of capital lease obligations
(75
)
 
(74
)
Net cash provided by (used in) financing activities
1,972

 
(2,418
)
Net decrease in cash and cash equivalents, unrestricted and restricted
(88,004
)
 
(62,182
)
Cash and cash equivalents, unrestricted and restricted, at beginning of period
779,677

 
672,941

Cash and cash equivalents, unrestricted and restricted, at end of period
$
691,673

 
$
610,759

Supplemental cash flow disclosure:
 
 

Cash paid during the period for:
 
 

Interest
$
1,961

 
$
1,262

Income taxes
$
113

 
$
171

Noncash financing and investing activities:
 
 
 
Property and equipment, accrued but not paid
$
4,063

 
$
523

Property and equipment financed under capital lease
$
142

 
$

໿

6


See accompanying notes to the condensed consolidated financial statements.

7


Notes to Condensed Consolidated Financial Statements
(Unaudited)




Note 1     Summary of Business and Significant Accounting Policies

Business

WageWorks, Inc., (together with its subsidiaries, “WageWorks” or the “Company”) was incorporated in the state of Delaware in 2000. The Company is a leader in administering Consumer-Directed Benefits (“CDBs”), which empower employees to save money on taxes while also providing corporate tax advantages for employers.

The Company operates as a single reportable segment on an entity level basis and considers itself to operate under one operating and reporting segment with healthcare, transit and other employer sponsored programs representing a group of similar products lines. The Company believes that it engages in a single business activity and operates in a single economic environment.

Basis of Presentation

The unaudited interim condensed consolidated financial statements and the related notes have been prepared on the same basis as the audited consolidated financial statements and reflect all adjustments that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The results of the interim period presented herein are not necessarily indicative of the results of future periods or annual results for the year ending December 31, 2018.

These unaudited interim condensed consolidated financial statements and the related notes should be read in conjunction with the December 31, 2017 audited financial statements and related notes, together with management’s discussion and analysis of financial condition and results of operations, included in the Company’s Annual Report on Form 10-K. The December 31, 2017 consolidated balance sheet, included in this interim Quarterly Report on Form 10-Q, was derived from audited financial statements. Certain prior year amounts in the condensed consolidated statements of cash flows have been reclassified to conform to the current year’s presentation.

Other than the adoption of ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)" and ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, there have been no material changes to our critical accounting policies and estimates during the three months ended March 31, 2018, as compared to the critical accounting policies and estimates disclosed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2017.

Principles of Consolidation

The unaudited condensed consolidated financial statements include the accounts of WageWorks, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Revenue Recognition

On January 1, 2018, we adopted the requirements of Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC 606”) as discussed further in Recently Adopted Accounting Pronouncements below. ASC 606 establishes a principle for recognizing revenue upon the transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services. ASC 606 also includes Subtopic 340-40, Other Assets and Deferred Costs-Contracts with Customers, which requires the deferral of incremental costs of obtaining a contract with a customer. Collectively, references to ASC 606 used herein refer to both ASC 606 and Subtopic 340-40.

We account for revenue contracts with customers by applying the requirements of ASC 606, which includes the following steps:

Identification of the contract, or contracts, with the customer;

8


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


Identification of the performance obligations in the contract;
Determination of the transaction price;
Allocation of the transaction price to the performance obligations in the contract; and
Recognition of the revenue when, or as, the Company satisfies a performance obligation.

Our revenues are derived primarily from benefit service administration, interchange and other commissions and other revenue which includes services related to enrollment and eligibility, non-healthcare, and employee account administration (i.e., tuition and health club reimbursements) and project-related professional services. We account for individual products and services separately if they are distinct-that is, if a product or service is separately identifiable from other items in the contract and if a customer can benefit from it on its own or with other resources that are readily available to the customer.

We account for a contract with a customer when there is approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. We measure revenue based on the consideration specified in the contract with each customer, net of any sales incentives and taxes collected on behalf of government authorities. We recognize revenue in a manner that best depicts the transfer of promised goods or services to the customer, when control of the product or service is transferred to a customer. We make significant judgments when determining the appropriate timing of revenue recognition.

Based upon similar operational and economic characteristics, the Company’s revenues are disaggregated into Healthcare, Commuter, COBRA and Other revenue. The Company believes these revenue categories depict how the nature, amount, timing, and uncertainty of its revenue and cash flows are affected by economic factors.

Healthcare and commuter programs include revenues generated from the monthly administration services based on employee participant levels and interchange and other commission revenues.
COBRA revenue is generated from the administration of continuation of coverage services for participants who are no longer eligible for the employer’s health benefits, such as medical, dental, vision and for the continued administration of employee participants’ Health Reimbursement Arrangements (“HRAs”), and certain healthcare Flexible Spending Accounts (“FSAs”).
Other revenue includes services related to enrollment and eligibility, non-healthcare, employee account administration (i.e., tuition and health club reimbursements).

Within our Healthcare and Commuter service lines, we have determined that our administration services are a single continuous service. These services are consumed as they are received and the Company recognizes service revenue over time on a monthly basis as it satisfies its performance obligations. As such, the Company recognizes revenue in each month for the administration services provided in that month using the variable consideration allocation exception.  The Company applies this exception because it concluded that the nature of its obligations and the variable payment terms are aligned and the uncertainty related to the consideration is resolved on a monthly basis as the Company satisfies its obligations. The administration services are typically billed in the period in which services are performed.

COBRA requires employers to make health coverage available for terminated employees for a period of up to 36 months post-termination. Similar to our Healthcare and Commuter service lines, our COBRA administration services are a single continuous service. These services are consumed as they are received and the Company recognizes service revenue over time on a monthly basis as it satisfies its performance obligations. As such, the Company recognizes revenue in each month for the COBRA administration services provided in that month using either the as-invoiced practical expedient or the variable consideration allocation exception. The administration services are typically billed in the period in which services are performed.

We also recognize revenues that are generated from the use of debit cards used by employee participants related to the distribution, management and monitoring of such cards and used in connection with our benefits administration services for Healthcare and Commuter service lines. These related fees are known as interchange fees and are based upon a percentage of the amounts transacted on each card. We have determined that our performance obligation for interchange is a single continuous service, which is satisfied over time each month. Therefore, we recognize interchange revenue on a monthly basis based on the services provided and use the variable consideration allocation exception. The interchange revenues are typically billed in the period in which services are performed.

9


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)



Contract Assets Contract assets include amounts related to our enforceable right to consideration for completed performance obligations not yet invoiced. The contract assets are transferred to the receivables balance when the rights become unconditional.

Contract Liabilities Contract liabilities are recorded as deferred revenues and include payments received in advance of performance under the contract. We generally invoice our customers for services as they are provided on a monthly basis, however in limited instances we may invoice in advance of services to be provided. Contract liabilities are recognized as revenue when the services are provided to the customer. Contract liabilities that are anticipated to be recognized during the succeeding twelve-month period are recorded as current deferred revenue and the remaining portion is recorded as noncurrent.

Contract Costs ASC 606 requires the recognition of an asset for the incremental costs of obtaining a contract with a customer if the entity expects to recover such costs. Incremental costs are costs that would not have been incurred if the contract had not been obtained. Examples of contract costs are commissions paid to sales personnel. Sales commissions earned by the Company’s sales force are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions for initial contracts are deferred and then amortized on a straight-line basis over a period of benefit that has been determined to be six years. The Company determined the period of benefit by taking into consideration length of customer contracts, useful life of developed technology, regulatory oversight the Company is subject to, and other factors. Amortization expense is included in Sales and marketing expenses on the condensed consolidated statements of income.

Use of Estimates

In preparing the Consolidated Financial Statements and related disclosure in conformity with United States (“U.S.”) generally accepted accounting principles (“GAAP”), including all adjustments as a result of the Company's restatement, and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"), the Company must make estimates and judgments that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Estimates are used for, but not limited to revenue recognition, allocation of purchase consideration to acquired assets and liabilities from business combinations, allowances for doubtful accounts, useful lives for depreciation and amortization, loss contingencies, income taxes, the assumptions used for stock-based compensation including attainment of performance-based awards, the assumptions used for software and web site development cost classification, and recoverability and impairments of goodwill and long-lived assets and average customer life. Actual results may be materially different from those estimates. In making its estimates, the Company considers the current economic and legislative environment.

Cash, Cash Equivalents, and Restricted Cash

The Company considers all highly liquid investments with an original maturity of 90 days or less to be cash equivalents. Cash and cash equivalents consist of cash on deposit with banks and money market funds, stated at cost, as well as commercial paper with an original maturity of less than 90 days as further described under Marketable Securities below. To the extent the Company’s contracts do not provide for any restrictions on the Company’s use of cash that it receives from clients, the cash is recorded as cash and cash equivalents.
 
The majority of the Company’s cash and cash equivalents represent funding and pre-funding balances received from customers for which the Company has a corresponding current obligation. In all cases where we have collected cash from a customer but not fulfilled services (the payment of participant healthcare claims and commuter benefits), the Company recognizes a related liability to its customers, classified as customer obligations in the accompanying consolidated balance sheets.
 
Restricted cash represents cash used to collateralize standby letters of credit which were issued to the benefit of a third party to secure a contract with the Company.

The following table summarizes the Company's cash and cash equivalents as at March 31, 2018 and December 31, 2017 (in thousands):


10


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


 
 
March 31, 2018
 
December 31, 2017
Cash and cash equivalents, unrestricted
 
691,341

 
779,345

Cash and cash equivalents, restricted
 
332

 
332

Total unrestricted and restricted cash and cash equivalents
 
691,673

 
779,677


Marketable Securities

The Company determines the classification of its investments in marketable securities at the time of purchase and accounts for them as available-for-sale. Marketable securities of highly liquid investments with stated maturities of three months or less when purchased are classified as cash equivalents and those with stated maturities of between three months and one year as short-term investments. Marketable securities with maturities beyond twelve months are also included in short-term investments within current assets as the Company intends for its investments to support current operations and other strategic initiatives. These securities are reported at fair value, which includes the accrued interest of interest-bearing securities. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive loss as a component of stockholders' equity, except for unrealized losses determined to be other-than-temporary which will be recorded within other income (expense). Realized gains and losses on the sale of marketable securities are recorded in other income (expense).

Receivables

Receivables represent both trade receivables from customers in relation to fees for the Company’s services and unpaid amounts for benefit services provided by third-party vendors, such as transit agencies and healthcare providers for which the Company records a receivable for funding and a corresponding customer obligations liability until the Company disburses the balances to the vendors.  The Company provides for an allowance for doubtful accounts by specifically identifying accounts with a risk of collectability and providing an estimate of the loss exposure. The Company reviews its allowance for doubtful accounts on a quarterly basis.  Account balances are written off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Write offs for the three months ended March 31, 2018 and 2017 were not significant.

The Company offsets on a customer by customer basis unpaid amounts for benefit services and customer obligation balances for financial reporting presentation. Additionally, the Company offsets outstanding trade and non-trade receivables, including any debit or credit memos, against any prefund balances after plan year close or upon termination of services both based on the completion of a full reconciliation with the customer.

Property and Equipment
 
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation on computer and equipment and furniture and fixtures is calculated on a straight-line basis over the estimated useful lives of those assets, ranging from three to five years. Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful life or the lease term. When events or circumstances suggest an asset’s life is different than initially estimated, management reassesses the useful life of the asset and recognizes future depreciation prospectively over the revised life.
 
When assets are retired or otherwise disposed of, the cost and related accumulated depreciation / amortization are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in operating expenses.
 
Maintenance and repairs are expensed as incurred. Expenditures that substantially increase an asset’s useful life are capitalized.
 
Software and Web Site Development Costs
 
Costs incurred to develop software for internal use are capitalized and amortized over the technology’s estimated useful life, generally four years. When events or circumstances suggest an asset’s life is different than initially estimated, management reassesses the useful life of the asset and recognizes future amortization prospectively over the revised life. Costs incurred related to the planning and post implementation phases of development are expensed as incurred. Costs associated with the platform content or the repair or maintenance, including transfer of data between existing platforms are expensed as incurred.



11


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and we consider counterparty credit risk in our assessment of fair value. Carrying amounts of financial instruments, including cash equivalents, accounts receivable, accounts payable, and accrued liabilities, approximate their fair values as of the balance sheet dates because of their short maturities. The carrying value of the Company’s debt under the credit facility is estimated to approximate fair value as the interest rate approximates the market rate for debt securities with similar terms and risk characteristics. The determination of the fair value of the Company’s marketable securities is further explained in Note 5 Investments and Fair Value Measurements.

The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:
Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.
Level 2 Inputs: Other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.

Impairment of Long-lived Assets

The Company reviews long-lived assets for indicators of impairment whenever events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. An impairment of long-lived assets exists when the carrying amount of a long-lived asset group, exceeds its fair value. Such impairment arises in circumstances when such assets are assessed and determined to have no continuing or future benefit. Impairment losses are recorded when the carrying amount of the impaired asset group is not recoverable. Recoverability is determined by comparing the carrying amount of the asset or asset group to the undiscounted cash flows which are expected to be generated from its use. If the carrying amount of the asset group exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset or asset group exceeds its fair value.
 
Acquisitions, Goodwill and Definite lived Intangible Assets

The cost of an acquisition is allocated to the tangible assets and definite lived intangible assets acquired and liabilities assumed based on their fair value at the date of acquisition. Goodwill represents the excess cost over the fair value of net assets acquired in the acquisition and is not amortized, but rather is tested for impairment.

Definite lived intangible assets, consisting of client/broker contracts and relationships, trade names, technology, noncompete agreements and favorable lease arrangements, are stated at cost less accumulated amortization. All definite lived intangible assets are amortized on a straight-line basis over their estimated remaining economic lives, generally ranging from one to ten years. Amortization expense related to these intangible assets is included in amortization expense on the consolidated statements of income.

The Company performs a goodwill impairment test annually on December 31st and more frequently if events and circumstances indicate that the asset might be impaired. The following are examples of triggering events that could indicate that the fair value of a reporting unit has fallen below the unit’s carrying amount:
A significant adverse change in legal factors or in the business climate

12


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


An adverse action or assessment by a regulator
Unanticipated competition
A loss of key personnel
A more likely than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of

An impairment loss is recognized to the extent that the carrying amount exceeds the reporting unit’s fair value. When reviewing goodwill for impairment, the Company assesses whether goodwill should be allocated to operating levels lower than the Company’s 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. The Company’s chief operating decision maker, the Chief Executive Officer, does not allocate resources or assess performance at the individual healthcare, commuter, COBRA or other revenue stream level, but rather at the operating segment level. Discrete financial information is therefore not maintained at the revenue stream level. The Company’s one reporting unit was determined to be the Company’s one operating segment.

Whenever events or circumstances change, entities have the option to first make a qualitative evaluation about the likelihood of goodwill impairment. In assessing the qualitative factors, the Company assesses relevant events and circumstances that may impact the fair value and the carrying amount of the reporting unit. The identification of relevant events and circumstances and how these may impact a reporting unit’s fair value or carrying amount involve significant judgments and assumptions. The judgment and assumptions include the identification of macroeconomic conditions, industry and market considerations, overall financial performance, Company specific events and share price trends and making the assessment on whether each relevant factor will impact the impairment test positively or negatively and the magnitude of any such impact.

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 the Company determines that the estimated fair value of the reporting unit is less than its carrying value, the Company moves 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 implied 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 in a manner similar to a purchase price allocation. If impairment is deemed more likely than not, management would perform the two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required.

Income Taxes
 
The Company reports income taxes using an asset and liability approach. Deferred tax assets and liabilities arise from the differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements, as well as from net operating loss and tax credit carryforwards. Deferred tax amounts are determined by using the tax rates expected to be in effect when the taxes will actually be paid or refunds received, as provided under current enacted tax law. 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. A valuation allowance reduces the deferred tax assets to the amount that is more likely than not to be realized.
 
The Company records a valuation allowance to reduce the deferred tax assets to the amount that the Company believes is more likely than not to be realized based on its judgment of all available positive and negative evidence. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which the strength of the evidence can be objectively verified. This assessment, which is completed on a taxing jurisdiction basis, takes into account a number of types of evidence, including the following:
The nature and history of current or cumulative financial reporting income or losses;
Sources of future taxable income;
The anticipated reversal or expiration dates of the deferred tax assets; and
Tax planning strategies.


13


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


The Company takes a two-step approach to recognizing and measuring the financial statement benefit of uncertain tax positions. The first step is to evaluate the tax position for recognition by determining whether the weight of available evidence indicates that it is more likely than not that the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement of the audit. The Company classifies interest and penalties on unrecognized tax benefits as income tax expense or benefit.

Customer Obligation Liability

Many of our customer agreements include provisions whereby our customers remit funds to us which represent prefunds of employer / client and employee participant contributions related to FSA, HRA and commuter programs.  The agreements do not represent restricted cash and accordingly the amounts received are included in cash and cash equivalents on our consolidated balance sheets with a corresponding liability recorded as customer obligations. Our customers generally 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 and other factors.  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 maintained throughout the year by our FSA, HRA and commuter clients as benefits are provided under these programs.

The Company offsets on a customer by customer basis non-trade accounts receivable and customer obligation balances for financial reporting presentation. Additionally, the Company offsets outstanding trade and non-trade receivables, including any debit or credit memos, against any prefund balances after plan year close or upon termination of services both based on the completion of a full reconciliation with the customer.

Recent Accounting Pronouncements

Recently Adopted Accounting Guidance

In May 2014, the Financial and Accounting Standards Board ("FASB") issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" , amending revenue recognition guidance and requiring more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers is effective for annual and interim reporting periods beginning after December 15, 2017, with early adoption permitted for public companies effective for annual and interim reporting periods beginning after December 15, 2016. We adopted ASC 606 on January 1, 2018 by applying the modified retrospective approach to all contracts that were not completed as of January 1, 2018. Results for the reporting period beginning January 1, 2018 are presented under ASC 606, while prior periods are not adjusted and continue to be reported under the accounting standards in effect for the prior period. We recorded an increase in total assets of $9.3 million and an increase in retained earnings of $6.9 million (net of tax effect) as of January 1, 2018 attributed to the deferral of commission cost. The tax impact resulted in an increase in deferred tax liabilities in the amount of $2.4 million with an offset to retained earnings upon adoption. See Note 3 Revenue for more details.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU No. 2016-18 addresses diversity in practice from entities classifying and presenting transfers between cash and restricted cash as operating, investing or financing activities or as a combination of those activities in the statement of cash flows. The ASU requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the Statement of Cash Flows. As a result, transfers between such categories are no longer be presented in the Statement of Cash Flows. The Company adopted this standard on January 1, 2018 using the retrospective method. This amendment did not have a material impact on the Company's condensed consolidated statements of income, balance sheet or cash flows.

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.” This guidance principally affects accounting standards for equity investments, financial liabilities where the fair value option has been elected, and the presentation and disclosure requirements for financial instruments. Upon the effective date of the new guidance, all equity investments in unconsolidated entities, other than those accounted for using the equity method of accounting, will generally be measured at fair value through earnings. There will no longer be an available-for-sale classification and therefore, no changes in fair value will be reported in other comprehensive income (loss) for equity securities with readily determinable fair values. The Company adopted this standard on January 1, 2018. This amendment did not have a material impact on the Company's condensed consolidated statements of income, balance sheet or cash flows.


14


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


In March 2016, the FASB issued Accounting Standard Update No. 2016-04, Recognition of Breakage for Certain Prepaid Stored-Value Products (“ASU 2016-04”). The new guidance creates an exception under ASC 405-20, Liabilities-Extinguishments of Liabilities, to derecognize financial liabilities related to certain prepaid stored-value products using a revenue-like breakage model. The Company adopted this update on January 1, 2018. This amendment did not have a material impact on the Company's condensed consolidated statements of income, balance sheet or cash flows.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash flows: Classification of Certain Cash Receipts and Cash Payments. The update provides specific guidance on a number of cash flow classification issues including contingent consideration payments made after a business combination, proceeds from settlement of insurance claims, proceeds from settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, distributions received from equity method investees and separately identifiable cash flows and application of the predominance principle. The Company adopted this update on January 1, 2018. This amendment did not have a material impact on the Company's condensed consolidated statements of income, balance sheet or cash flows.

In May 2017, the FASB issued ASU No. 2017-09, Compensation-Stock Compensation: Scope of Modification Accounting ("ASU 2017-09"). The update amends the scope of modification accounting for shared-based payment arrangements to specify that modification accounting would not be applicable if the fair value, vesting conditions and classification of the shared-based awards are the same immediately before and after the modification. The Company adopted this update on January 1, 2018. This update did not have a material impact on the Company's condensed consolidated statements of income, balance sheet or cash flows.
 
Recently Issued Accounting Pronouncements
In February 2016, the FASB, issued ASU, No. 2016-02, Leases (Topic 842), which requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases.
The Company will adopt the standard effective in the first quarter of 2019 and will not restate comparative periods upon adoption. The Company will elect a package of practical expedients for leases that commenced prior to January 1, 2019 and will not reassess: (i) whether any expired or existing contracts are or contain leases; (ii) lease classification for any expired or existing leases; and (iii) initial direct costs capitalization for any existing leases. The Company will make an accounting policy election to keep leases with an initial term of 12 months or less off of the balance sheet. The Company will recognize those lease payments in the consolidated statements of income on a straight-line basis over the lease term.

The Company currently expects that our operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon its adoption of Topic 842, which will increase the total assets and total liabilities that were reported relative to such amounts prior to adoption. Refer to Note 14 for further information on operating lease commitments. The Company plans to adopt Topic 842 using the alternative modified retrospective approach with the cumulative effect of adoption recognized to retained earnings on January 1, 2019. The Company does not believe the new standard will have a material impact on the consolidated statements of income, nor will it have a notable impact on liquidity. The standard will also have no material impact on debt-covenant compliance under our current agreements.

 In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," which amends the FASB's guidance on the impairment of financial instruments. The ASU adds to GAAP an impairment model (known as the "current expected credit loss model") that is based on expected losses rather than incurred losses. ASU 2016-13 is effective for annual reporting periods ending after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the timing and impact of adoption on the Company's consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." The amendments eliminate Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized

15


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


should not exceed the total amount of goodwill allocated to that reporting unit. In addition, income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The new standard is expected to be effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company is currently evaluating the timing of adoption; however, it does not believe this ASU will have a material impact on the Company's consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”. This standard allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act and requires certain disclosures about stranded tax effects and will be effective for the Company beginning January 1, 2019 and should be applied either in the period of adoption or retrospectively. Early adoption is permitted. The Company is currently evaluating the timing of adoption; however, it does not believe this ASU will have a material impact on the Company's consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement." The primary focus of ASU 2018-13 is to improve the effectiveness of the disclosure requirements for fair value measurements. The changes affect all companies that are required to include fair value measurement disclosures. In general, the amendments in this standard are effective for all entities for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. The Company is currently evaluating the timing of adoption; however, it does not believe this ASU will have a material impact on the Company's consolidated financial statements.

In November 2018, the FASB issued ASU No. 2018-19, "Codification Improvements to Topic 326, Financial Instruments-Credit Losses." ASU 2018-19 clarifies that receivables arising from operating leases are not within the scope of the credit losses standard, but rather, should be accounted for in accordance with the leases standard. In general, the amendments in this standard are effective for public business entities that meet the definition of a SEC filer for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The Company is currently evaluating the timing of adoption; however, it does not believe this ASU will have a material impact on the Company's consolidated financial statements.

Note 2     Net Income per Share

The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share data):
໿
 
Three months ended March 31,
 
2018
 
2017
Numerator for basic net income per share:
 
 
 
Net income
$
11,019

 
$
16,057

Denominator for basic net income per share:
 
 
 
Weighted-average common shares outstanding
39,823

 
37,025

Basic net income per share
$
0.28

 
$
0.43

 
 
 
 
Numerator for diluted net income per share:
 
 
 
Net income
$
11,019

 
$
16,057

Denominator for diluted net income per share:
 
 
 
Weighted-average common shares outstanding
39,823

 
37,025

Dilutive stock options, restricted stock and performance restricted stock units and employee stock purchase plan shares
657

 
1,416

Diluted weighted-average common shares outstanding
40,480

 
38,441

Diluted net income per share
$
0.27

 
$
0.42



16


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


Stock options and restricted stock units to purchase common stock are not included in the computation of diluted earnings per share if their effect would be anti-dilutive. The Company excluded 1.4 million and 0.6 million anti-dilutive share equivalents in the calculation of diluted earnings per share for the three months ended March 31, 2018 and 2017, respectively.

Note 3     Revenue

On January 1, 2018, we adopted ASC 606, applying the modified retrospective method to all contracts that were not completed as of that date. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period results are not adjusted and continue to be reported in accordance with Topic 605, Revenue Recognition. See the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 for our accounting policies applied to revenue recognition prior to adoption of ASC 606. We generally invoice our customers at the beginning of the term on a monthly basis with a term of net 30-60 days. We applied the practical expedient provided by ASC 606 and did not evaluate contracts of one year or less for the existence of a significant financing component. Our policy is to exclude sales and other indirect taxes when measuring the transaction price of its subscription agreements. The primary impact of adopting ASC 606 relates to the deferral of incremental costs of obtaining customer contracts and the amortization of those costs over the period of benefit. We recorded an increase in total assets of $9.3 million and an increase in retained earnings of $6.9 million (net of tax effect) as of January 1, 2018. The tax impact resulted in an increase in deferred tax liabilities in the amount of $2.4 million with an offset to retained earnings upon adoption. The adoption of the preceding standard did not have a material impact on the Company's revenue for the three months ended March 31, 2018.

Disaggregation of Revenue

The Company's primary categories of revenue are Healthcare, Commuter, COBRA and Other revenue and are disclosed in the condensed consolidated statements of income. The following table provides information about disaggregated revenue from contracts with customers by the nature of the products and services (in thousands):

 
 
Three Months Ended March 31
 
 
2018
 
2017
Benefit administration services and COBRA
 
$
104,440

 
$
106,585

Interchange
 
15,745

 
15,037

Other revenue
 
6,455

 
4,415

 
 
$
126,640

 
$
126,037


Contract Balances

We generally do not recognize revenue in advance of invoicing our customers, however, we record a receivable when revenue is recognized prior to payment and we have unconditional right to payment. Alternatively, when payment precedes the related services, we record a contract liability, or deferred revenue, until our performance obligations are satisfied. Our deferred revenue as of March 31, 2018 and December 31, 2017 was $16.9 million and $3.4 million net of $1.0 million of contract assets, respectively. The balances relate to cash received in advance for a certain interchange revenue arrangement, other up-front fees and other commuter deferred revenue. The Company expects to satisfy its remaining obligations for these arrangements.

Contract Costs

Contract costs relate to incremental costs of obtaining a contract with a customer. Contract costs, which primarily consist of deferred sales commissions, were $9.4 million and $9.3 million as of March 31, 2018 and January 1, 2018, respectively and are included in other assets on the condensed consolidated balance sheets. Amortization expense for the deferred costs was $0.6 million for the three months ended March 31, 2018. There was no impairment loss in relation to the costs capitalized for the periods presented. Deferred contract costs are amortized on a straight-line basis over the period of benefit, which is consistent with the pattern of transfer of the good or service to which the asset relates. The Company has applied the practical expedient which allows and entity to account for incremental costs of obtaining a contract at a portfolio level.

Performance Obligations

17


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)



During the three months ended March 31, 2018, the Company recognized revenue of $0.3 million attributable to changes in the estimated transaction price allocated to performance obligations satisfied in prior periods.

The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period, in thousands. The Company applies the practical expedient to not disclose information about contracts with original expected durations of one year or less, amounts of variable consideration attributable to the variable consideration allocation exception, or contract renewals that are unexercised as of March 31, 2018 (in thousands):
 
 
2018
 
2019
 
2020
 
2021 and thereafter
 
Total
 
 
$
429

 
571

 
571

 
1,716

 
$
3,287


Impacts on Financial Statements

In accordance with Topic 606, the disclosure of the impact of adoption to our unaudited condensed consolidated statements of income and balance sheets and statements of cash flows was as follows (in thousands, except per share amounts):
 
 
Three Months Ended March 31, 2018
 
 
As reported
 
Adjustments
 
Balance without adoption of ASC 606
Operating expenses:
 
 
 
 
 
 
Sales and marketing
 
$
18,338

 
49

 
$
18,387

 
 
 
 
 
 
 
Total operating expenses
 
111,853

 
49

 
111,902

 
 
 
 
 
 
 
Income from operations
 
14,787

 
(49
)
 
14,738

 
 
 
 
 
 
 
Income before income taxes
 
13,871

 
(49
)
 
13,822

 
 
 
 
 
 
 
Income tax provision
 
(2,852
)
 
10

 
(2,842
)
 
 
 
 
 
 
 
Net income
 
11,019

 
(39
)
 
10,980

 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
Basic
 
$
0.28

 
 
 
$
0.28

Diluted
 
$
0.27

 
 
 
$
0.27


 
 
March 31, 2018
 
 
As reported
 
Adjustments
 
Balance without adoption of ASC 606
Assets
 
 
 
 
 
 
Other assets
 
$
23,070

 
$
(6,995
)
 
$
16,075

Total assets
 
1,652,763

 
(6,995
)
 
1,645,768

 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
 
 
Retained earnings
 
90,715

 
(6,995
)
 
83,720

Total Stockholders' equity
 
$
638,960

 
$
(6,995
)
 
$
631,965


18


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)




Note 4     Goodwill and Intangible Assets
 
Goodwill

There is no change in the carrying amount of goodwill for the three months ended March 31, 2018.

Intangible Assets

Acquired intangible assets at March 31, 2018 and December 31, 2017 were comprised of the following (in thousands):

 
March 31, 2018
 
December 31, 2017
 
Gross
carrying
amount
 
Accumulated
amortization
 
Net
 
Gross
carrying
amount
 
Accumulated
amortization
 
Net
Amortizable intangible assets:
 
 
 
 
 
 
 
 
 
 
 
Client/broker contracts and relationships
$
237,291

 
$
(90,633
)
 
$
146,658

 
$
237,221

 
$
(84,581
)
 
$
152,640

Trade names
3,880

 
(3,516
)
 
364

 
3,880

 
(3,492
)
 
388

Technology
14,646

 
(13,288
)
 
1,358

 
14,646

 
(13,047
)
 
1,599

Noncompete agreements
2,232

 
(2,031
)
 
201

 
2,232

 
(2,013
)
 
219

Favorable lease agreements
1,134

 
(637
)
 
497

 
1,134

 
(611
)
 
523

Total
$
259,183

 
$
(110,105
)
 
$
149,078

 
$
259,113

 
$
(103,744
)
 
$
155,369



Amortization of intangible assets totaled $6.4 million and $6.5 million for the three months ended March 31, 2018 and 2017, respectively.

Acquired intangible assets are amortized on a straight-line basis generally over one to ten years.

The estimated amortization expense in future periods at March 31, 2018 is as follows (in thousands):
໿
 
As of
March 31, 2018
Remainder of 2018
$
19,091

2019
24,894

2020
22,729

2021
19,925

2022
17,489

Thereafter
44,950

Total
$
149,078



19


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


Note 5 Investments and Fair Value Measurements

The following table summarizes the Company's investments in marketable securities and fair value measurements by investment category reported as cash equivalents and short-term investments as of March 31, 2018 (in thousands):
 
 
Carrying Amount
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Fair Value
 
Level 1
 
Level 2
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
83

 
$

 
$

 
$
83

 
$
83

 
$

Commercial paper
 
16,585

 

 
(3
)
 
16,582

 

 
16,582

Total cash equivalents
 
$
16,668

 
$

 
$
(3
)
 
$
16,665

 
$
83

 
$
16,582

 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government securities
 
$
28,891

 
$

 
$
(121
)
 
$
28,770

 
$
28,770

 
$

U.S. government agency securities
 
14,295

 
1

 
(68
)
 
14,228

 

 
14,228

Municipal bonds
 
7,006

 

 
(8
)
 
6,998

 

 
6,998

Foreign government securities
 
14,960

 

 
(89
)
 
14,871

 

 
14,871

Corporate debt securities
 
140,623

 
8

 
(934
)
 
139,697

 

 
139,697

Commercial paper
 
22,749

 

 
(13
)
 
22,736

 

 
22,736

Certificates of deposit
 
1,255

 

 

 
1,255

 

 
1,255

Asset-backed securities
 
31,645

 

 
(211
)
 
31,434

 

 
31,434

Total short-term investments
 
$
261,424

 
$
9

 
$
(1,444
)
 
$
259,989

 
$
28,770

 
$
231,219

Total cash equivalents and short-term investments
 
$
278,092

 
$
9

 
$
(1,447
)
 
$
276,654

 
$
28,853

 
$
247,801


The following table summarizes the Company's investments in marketable securities and fair value measurements by investment category reported as cash equivalents and short-term investments as of December 31, 2017 (in thousands):

 
 
Carrying Amount
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Fair Value
 
Level 1
 
Level 2
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
 
$
58,953

 
$

 
$

 
$
58,953

 
$
58,953

 
$

Commercial paper
 
21,930

 

 
(3
)
 
21,927

 

 
21,927

Total cash equivalents
 
$
80,883

 
$

 
$
(3
)
 
$
80,880

 
$
58,953

 
$
21,927

 
 
 
 
 
 
 
 
 
 
 
 
 
Short-Term Investments:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government securities
 
$
17,472

 
$

 
$
(41
)
 
$
17,431

 
$
17,431

 
$

U.S. government agency securities
 
11,540

 

 
(30
)
 
11,510

 

 
11,510

Municipal bonds
 
6,974

 
2

 
(8
)
 
6,968

 

 
6,968

Foreign government securities
 
7,499

 

 
(27
)
 
7,472

 

 
7,472

Corporate debt securities
 
105,144

 
3

 
(273
)
 
104,874

 

 
104,874

Commercial paper
 
30,798

 
1

 
(9
)
 
30,790

 

 
30,790

Certificates of deposit
 
1,255

 

 

 
1,255

 

 
1,255

Asset-backed securities
 
15,310

 

 
(76
)
 
15,234

 

 
15,234

Total short-term investments
 
$
195,992

 
$
6

 
$
(464
)
 
$
195,534

 
$
17,431

 
$
178,103

Total cash equivalents and short-term investments
 
$
276,875

 
$
6

 
$
(467
)
 
$
276,414

 
$
76,384

 
$
200,030




20


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


As of March 31, 2018, the Company had no investments that were in an unrealized loss position for a period of twelve months or greater and have determined that the gross unrealized losses on investments are temporary in nature.

Realized gains and losses on marketable securities are included in other income (expense) on the Company's consolidated statements of income. Gross realized gains and losses on marketable securities for the three months ended March 31, 2018 were not significant.

The Company uses inputs such as actual trade data, benchmark yields, quoted market prices from dealers or brokers, and other similar sources to determine the fair value of its investments. There were no transfers between Level 1 and Level 2 fair value categories during the periods presented.

The following table summarizes the estimated amortized cost and fair value of the Company's marketable securities by the contractual maturity date as at March 31, 2018 (in thousands):
 
 
Amortized Cost
 
Fair Value
Due less than one year
 
$
124,173

 
$
123,882

Due in one to five years
 
153,919

 
152,772

Total
 
$
278,092

 
$
276,654


The following table summarizes the estimated amortized cost and fair value of the Company's marketable securities by the contractual maturity date as at December 31, 2017 (in thousands):

 
 
Amortized Cost
 
Fair Value
Due less than one year
 
$
157,651

 
$
157,573

Due in one to five years
 
119,224

 
118,841

Total
 
$
276,875

 
$
276,414




Note 6    Receivables

Receivables at March 31, 2018 and December 31, 2017 were comprised of the following (in thousands):

 
March 31,
2018
 
December 31,
2017
Trade receivables
$
65,306

 
$
58,067

Unpaid amounts for benefit services
63,484

 
52,054

Receivables, gross
128,790

 
110,121

Less: allowance for doubtful accounts
(2,574
)
 
(2,574
)
Receivables, net
$
126,216

 
$
107,547




21


Note 7     Property and Equipment

Property and equipment at March 31, 2018 and December 31, 2017 were comprised of the following (in thousands):

 
March 31,
2018
 
December 31,
2017
Computers and equipment
$
24,707

 
$
22,702

Software and software development costs
126,312

 
120,278

Furniture and fixtures
7,772

 
7,754

Leasehold improvements
26,046

 
25,097

 
$
184,837

 
$
175,831

Less: accumulated depreciation and amortization
(113,308
)
 
(107,089
)
Property and equipment, net
$
71,529

 
$
68,742


As of March 31, 2018 and December 31, 2017, total assets under capital lease obligations were $1.8 million and $1.7 million respectively, and were classified as computers and equipment. Accumulated depreciation for assets under capital lease obligations was $1.2 million and $1.1 million as at March 31, 2018 and December 31, 2017.

The Company capitalized software development costs of $5.7 million and $4.1 million for the three months ended March 31, 2018 and 2017, respectively. Amortization expense related to capitalized software development costs was $3.6 million and $2.7 million for the three months ended March 31, 2018 and 2017, respectively. These costs are included in amortization in the condensed consolidated statements of income. At March 31, 2018, the unamortized software development costs included in property and equipment in the condensed consolidated balance sheets were $36.7 million.

Total depreciation expense plus amortization of software and internally developed software for the three months ended March 31, 2018 and 2017 was $6.8 million and $5.3 million, respectively.


Note 8     Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses at March 31, 2018 and December 31, 2017 were comprised of the following (in thousands):

 
March 31,
2018
 
December 31,
2017
Payable to benefit providers and transit agencies
$
24,655

 
$
23,788

Accounts payable and accrued liabilities
26,841

 
32,469

Accrued compensation and related benefits
24,229

 
25,921

Other accrued expenses
5,555

 
5,275

Deferred revenue
15,036

 
2,524

Accounts payable and accrued expenses
$
96,316

 
$
89,977




22


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


Note 9     Long-term debt

As of March 31, 2018 and December 31, 2017, long-term debt consisted of the following (in thousands):

 
March 31,
2018
 
December 31,
2017
Revolving credit facility used
$
249,830

 
$
249,830

Less: Outstanding letters of credit
(2,830
)
 
(2,830
)
Outstanding revolving credit facility
247,000

 
247,000

Unamortized loan origination fees
(1,965
)
 
(2,085
)
Long-term debt
$
245,035

 
$
244,915


On April 4, 2017, the Company entered into a Second Amended and Restated Credit Agreement (the “Credit Agreement”) with MUFG Union Bank, N.A., as administrative agent (“Agent”). The Credit Agreement amends and restates the Company’s existing Amended and Restated Credit Agreement, and increased the Company's borrowing capacity under the revolving credit facility to $400.0 million, with a $15.0 million letter of credit sub-facility. The Credit Agreement contains an increase option permitting the Company, subject to certain conditions and requirements, to arrange with existing lenders and/or new lenders to provide up to an aggregate of $100.0 million in additional commitments. Loan proceeds may be used for general corporate purposes, including acquisitions permitted under the Credit Agreement. The Company may prepay loans under the Credit Agreement in whole or in part at any time without premium or penalty. The fees incurred in connection with the Credit Agreement are classified as a direct deduction from long-term debt in the condensed consolidated balance sheets.

The loans bear interest, at the Company’s option, at either (i) a London Interbank Offered Rate (LIBOR) determined in accordance with the Credit Agreement, plus a margin ranging from 1.25% to 2.25%, or (ii) a base rate determined in accordance with the Credit Agreement, plus a margin ranging from 0.25% to 1.25%, in either case with such margin determined based on the Company’s consolidated leverage ratio for the preceding four fiscal quarter period. Interest is due and payable in arrears quarterly for base rate loans and at the end of an interest period for LIBOR rate loans. Principal, together with all accrued and unpaid interest, is due and payable on April 4, 2022. The Company elected option (i) and, as of March 31, 2018, the interest rate applicable to the revolving credit facility was 3.24%.

The Company’s obligations under the Credit Agreement are secured by substantially all of the Company’s assets. All of the Company’s existing and future material subsidiaries are required to guarantee its obligations under the Credit Agreement. The guarantees by future material subsidiaries are and will be secured by substantially all of the assets of such subsidiaries.

The Credit Agreement contains financial and non-financial covenants including debt ratio and interest coverage ratio requirements. The Company is currently in compliance with all the covenants under the credit facility.

On April 5, 2018, the Company's Board of Directors concluded the previously issued financial statements for (i) the quarterly periods ended September 30, June 30 and March 31, 2017, (ii) the annual period ended December 31, 2016 and (iii) the quarterly periods ended September 30 and June 30, 2016 (collectively, the “Non-Reliance Periods”) should be restated and should no longer be relied upon. On March 22, 2018 the Company entered a “First Reporting Extension” Agreement and on June 25, 2018 entered a “Second Reporting Extension” Agreement. These agreements are amendments to the Credit Agreement dated April 4, 2017 and provide credit accommodations to the Company in the form of modification of the reporting and Compliance Certificates. In 2018, the Company paid the Agent $0.8 million to extend the delivery date of the delinquent financial statements to March 16, 2019 pursuant to the Reporting Extension Agreement. In March 2019, the Company entered into a Third Reporting Extension Agreement and paid the Agent $0.1 million to extend the delivery date of any remaining delinquent financial statements to May 10, 2019.

As of March 31, 2018, the Company had $247.0 million outstanding under the revolving credit facility and $150.2 million unused revolving credit facility still available to borrow under the Credit Agreement.

The credit facility contains customary events of default including, among others, payment defaults, covenant defaults, inaccuracy of representations and warranties, cross-defaults to other material indebtedness, judgment defaults, a change of control default and bankruptcy, and insolvency defaults.  Under certain circumstances, a default interest rate will apply on all obligations during the existence of an event of default under the loan agreement at a per annum rate of interest equal to 2.00% above the

23


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


applicable interest rate. Upon an event of default, the lenders may terminate the commitments, declare the outstanding obligations payable by the Company to be immediately due and payable, and exercise other rights and remedies provided for under the credit facility.


Note 10     Organizational Efficiency Plan

During the second quarter of 2015, the Company integrated operations and consolidated certain positions resulting in employee headcount reductions. The Company continually evaluates ways to improve business processes to ensure that operations align with its strategy and vision for the future. During the three months ended March 31, 2018, the Company did not incur any employee termination or facility closure costs. In the three months ended March 31, 2017, the Company recorded a charge of $0.7 million in employee termination and other charges expense line item.


Note 11     Employee Benefit Plans

Stock-based compensation

Stock-based compensation is classified in the condensed consolidated statements of income in the same expense line items as cash compensation. Amounts recorded as expense in the condensed consolidated statements of income were as follows (in thousands):  
 
Three Months Ended March 31,
 
2018
 
2017
Cost of revenues
$
1,667

 
$
1,740

Technology and development
575

 
611

Sales and marketing
978

 
786

General and administrative
4,073

 
643

Total
$
7,293

 
$
3,780


(a) Employee Stock Option Plan

In May 2010, the Company adopted the 2010 Equity Incentive Plan ("2010 Plan"). Under the 2010 Plan, the Company can grant share-based awards to all employees, including executive officers, outside consultants and non-employee directors. Options under 2010 Plan generally has a term of 10 years and vest over 4 years with 25% vesting after one year of service and monthly vesting over the remaining period. As of March 31, 2018, the 2010 Plan has a total of 3.4 million common stock shares available for issuance.

The following table summarizes the weighted-average fair value of stock options granted:
 
Three Months Ended March 31,
 
2018
 
2017
Stock options granted (in thousands)

 
518

Weighted-average fair value at date of grant
$

 
$
26.74



24


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


Stock option activity for the three months ended March 31, 2018 was as follows (shares in thousands):
 
Shares
 
Weighted-average
exercise price
 
Remaining
contractual term
(in years)
 
Aggregate
intrinsic value
(in thousands)
Outstanding at December 31, 2017
2,478

 
$
47.24

 
7.22
 
$
42,324

Granted

 

 
 
 
 
Exercised
(54
)
 
26.10

 
 
 
 
Forfeited and cancelled
(14
)
 
54.68

 
 
 
 
Outstanding as of March 31, 2018
2,410

 
$
47.67

 
5.60
 
$
14,900

Vested and expected to vest at March 31, 2018
2,330

 
$
47.27

 
5.60
 
$
14,861

Exercisable at March 31, 2018
1,470

 
$
40.26

 
5.10
 
$
14,405



As of March 31, 2018, there was $16.3 million of total unrecognized stock-based compensation expense associated with stock options which will be recognized over a weighted-average period of approximately 2 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.

(b) Restricted Stock Units

The Company grants restricted stock units ("RSU") to certain employees, officers, and directors under the 2010 Plan. Restricted stock units vest upon performance-based, market-based, or service-based criteria.

In the first quarter of 2018, the Company granted no performance-based restricted stock units. During the same period in 2017, the Company granted 343,000 of performance-based restricted stock units to certain executive officers. Performance-based restricted stock units are typically granted such that they vest upon the achievement of certain revenue growth rates and other financial metrics during a specified performance period for which participants have the ability to receive up to 200% of the target number of shares originally granted, depending on terms of the grant agreement.  
 
Stock-based compensation expense related to restricted stock units was $4.1 million and $0.9 million for the three months ended March 31, 2018 and 2017, respectively. Total unrecorded stock-based compensation expense at March 31, 2018 associated with restricted stock units was estimated at $19.1 million, which is expected to be recognized over a weighted-average period of 2 years.

The following table summarizes information about restricted stock units issued to officers, directors and employees under the 2010 Plan (shares in thousands):
 
(Shares in thousands)
 
Weighted-average grant date fair value
 
Service-
based RSUs
 
Performance-
based RSUs
 
Service-
based RSUs
 
Performance-
based RSUs
Unvested at December 31, 2017
304

 
725

 
$
61.61

 
$
60.21

Granted

 

 

 

Vested
(14
)
 
(140
)
 
57.74

 
61.10

Forfeited and cancelled
(6
)
 

 
60.31

 

Unvested at March 31, 2018
284

 
585

 
$
61.82

 
$
60.00



Note 12     Stockholders’ Equity

Share Repurchase Program

On August 6, 2015, the Company’s Board of Directors authorized a $100 million stock repurchase program for 3 years which commenced on November 5, 2015 and expires on November 4, 2018. Repurchases made under this program may be made in the open market as the Company deems appropriate and market conditions allow. There were no shares of common stock repurchased during the three months ended March 31, 2018 and 2017. In August 2017, the Company repurchased 134,900 shares of its common

25


Notes to Condensed Consolidated Financial Statements (continued)
(Unaudited)


stock at an average price of $58.82 per share for a total cost of $7.9 million. As of March 31, 2018, the Company had $77.7 million available for future purchases under the stock repurchase program.


Note 13     Income Taxes 

The Company reports income taxes using an asset and liability approach, under which deferred income taxes are provided based upon enacted tax laws and rates applicable to periods in which the taxes become payable. The Company is subject to income taxes in the U.S. federal and various state jurisdictions. Presently, there are no income tax examinations on-going in the jurisdictions where the Company operates.

The Company's effective tax rate was 20.6% and 25.5% for the three months ended March 31, 2018 and 2017, respectively. The income tax provision for the three months ended March 31, 2018 and 2017 was $2.9 million and $5.5 million, respectively.

As of March 31, 2018, the Company remains in a net deferred tax asset position. The realization of the Company’s deferred tax assets depends primarily on its ability to generate sufficient U.S. taxable income in future periods. The amount of deferred tax assets considered realizable may increase or decrease in subsequent quarters as management reevaluates the underlying basis for the estimates of future domestic taxable income.


Note 14    Commitments and Contingencies

(a) Capital Lease Obligations

The Company leases equipment under capital lease obligations that expire at various expiration dates through 2020. Future minimum lease payments under capital lease obligations as of March 31, 2018 are $1.0 million. The Company recorded current and long-term portions of capital lease obligations under other current liabilities and non-current liabilities, respectively, in the consolidated balance sheets. The Company has no future minimum lease payments under capital lease obligations extending beyond 2020.

(b) Operating Leases

The Company leases office space and equipment under noncancelable operating leases with various expiration dates through 2028. Future minimum lease payments under noncancelable operating leases, excluding the contractual sublease income of $9.7 million, are as follows (in thousands):
 
As of
March 31, 2018
Remainder of 2018
$
6,870

2019
9,522

2020
9,721

2021
9,689

2022
6,536

Thereafter
7,970

Total future minimum lease payments
$
50,308

 
Rent expense for the three months ended March 31, 2018 and 2017 was $2.0 million and $1.9 million, respectively. Sublease income for the three months ended March 31, 2018 and 2017 was $0.5 million and $0.3 million, respectively.

(c) Legal Matters

The Company is pursuing affirmative claims against the OPM to obtain payment for services provided by the Company between March 1, 2016 and August 31, 2016 pursuant to our contract with OPM for the Government’s Federal Flexible Account Program (“FSAFEDS”). The Company initially issued its invoice for these services in February 2017. On December 22, 2017, the Company received the Contracting Officer’s “final decision” refusing payment of the invoiced amount and

26


otherwise denying the Company’s Certified Claim. As a result of this decision, and a related Certified Claim that OPM subsequently denied, on February 8, 2018, we filed an appeal to the Civilian Board of Contract Appeals (“CBCA”) against OPM for services provided by the Company between March 1, 2016 and August 31, 2016. On August 3, 2018, we filed an appeal to the CBCA of OPM’s June 21, 2018 denial of a Request for Equitable Adjustment for extra work associated with a contract modification imposing new security and other requirements not part of the original scope of FSAFED’s contract work. The aggregate amount of our claims is approximately $9.1 million. The cases have been consolidated and discovery is ongoing.
    
There have been multiple discovery motions, as well as motion to dismiss the claim we filed on August 3, 2018 which has been fully briefed and is awaiting a decision by the CBCA.  The cases had been set for a hearing on the merits on April 24, 2019.  However, because of the recent partial Government shutdown, the trial date has been postponed and has been tentatively scheduled for mid-June 2019.  In connection with the Company’s claims against OPM, OPM has also claimed that an erroneous statement in a certificate signed by a former executive officer constituted a violation of the False Claims Act, and has moved to dismiss part of our claim against OPM as a result.  As with all legal proceedings, no assurance can be provided as to the outcome of these matters or if we will be successful in recovering the full claimed amount.

On March 9, 2018, a putative class action - captioned Government Employees’ Retirement System of the Virgin Islands v. WageWorks, Inc., et al., No. 4:18-cv-01523-JSW - was filed in the United States District Court for the Northern District of California (the “Securities Class Action”) against the Company, our former Chief Executive Officer, and our former Chief Financial Officer. The complaint asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), on behalf of persons and entities that acquired WageWorks securities between May 6, 2016 and March 1, 2018, and alleges, among other things, that the defendants issued false and misleading financial statements. The plaintiffs seek unspecified damages, fees, interest, and costs. The Company believes that the claims are without merit. On August 7, 2018, the Court entered an order granting the motion of the Public Pension Group, consisting of Public Employees’ Retirement System of Mississippi, the Government Employees’ Retirement System of the Virgin Islands, and the New Mexico Public Employees Retirement Association of New Mexico, to be lead plaintiff. Under the schedule stipulated by the parties, and approved by the Court, lead plaintiff will file its consolidated amended complaint no later than forty-five (45) days following issuance of the Company’s Restatement.

On June 22, 2018 and September 6, 2018, two derivative lawsuits were filed against certain of our officers and directors and the Company (as nominal defendant) in the Superior Court of the State of California, County of San Mateo.  Pursuant to the parties’ stipulation, which was approved by the Superior Court, the actions were consolidated. On July 23, 2018, a similar derivative lawsuit was filed against certain of our officers and directors and the Company (as nominal defendant) in the United States District Court for the Northern District of California (together, the “Derivative Suits”). The Derivative Suits purport to allege claims related to breaches of fiduciary duties, waste of corporate assets, and unjust enrichment. In addition, the complaint in District Court includes a claim for abuse of control, and the complaint in Superior Court includes a claim to require the Company to hold an annual shareholder meeting. The allegations in the Derivative Suits relate to substantially the same facts as those underlying the Securities Class Action described above. The plaintiffs seek unspecified damages and fees and costs. In addition, the complaint in the Superior Court seek for us to provide past operational reports and financial statements, to publish timely and accurate operational reports and financial statements going forward, to hold an annual shareholder meeting, and to take steps to improve its corporate governance and internal procedures.

Under the schedule stipulated by the parties, and approved by the Superior Court, the plaintiff in the Superior Court action will file its Consolidated Complaint within 45 days from the date we issue our Restatement.  As stipulated by the parties, and approved by the District Court, the District Court action is stayed. The parties in the District Court action are to notify the District Court within 15 days of (1) the dismissal of the Securities Class Action, (2) the denial of defendants' motion(s) to dismiss, or (3) a party giving notice that they no longer consent to the voluntary stay.

From time to time, the Company may become involved in legal proceedings, claims and litigation arising in the ordinary course of business.

The Company voluntarily contacted the San Francisco office of the SEC Division of Enforcement regarding the restatement and independent investigation. The Company is providing information and documents to the SEC and will continue to cooperate with the SEC’s investigation into these matters. The U.S. Attorney’s Office for the Northern District of California also opened an investigation. The Company has provided documents and information to the U.S. Attorney’s Office and will continue to cooperate with any inquiries by the U.S. Attorney’s Office regarding the matter.

27



The Company records a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Based on currently available information, the Company does not believe that any additional liabilities relating to other unresolved matters are probable or that the amount of any resulting loss is estimable. However, litigation is subject to inherent uncertainties and the Company's view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on the Company's financial position, results of operations or cash flows for the period in which the unfavorable outcome occurs, and potentially in future periods.


Note 15    Subsequent Events

At the beginning of the second quarter of 2018, and in conjunction with the Company’s announcement of its intention to restate its financial statements for (i) the quarterly and year-to-date periods ended June 30 and September 30, 2016, (ii) the year ended December 31, 2016 and (iii) the quarterly and year-to-date periods ended March 31, June 30 and September 30, 2017, the Company announced certain changes to its management team, effective April 5, 2018, including:
Mr. Joseph L. Jackson resigning from his position as Chief Executive Officer, and being appointed Executive Chairman of the Company.
Mr. Edgar O. Montes being appointed President and Chief Executive Officer, and being appointed to serve as a member of the Board.
Mr. Colm M. Callan resigning from his position as Chief Financial Officer, and continuing his employment with the Company to effect a seamless transition to the incoming interim chief financial officer, followed by the termination of his employment on July 4, 2018.
Ms. Kimberly L. Wilford resigning from her position as Senior Vice President, General Counsel and Corporate Secretary of the Company, and continuing her employment with the Company to effect a seamless transition, followed by the termination of her employment on July 4, 2018.

The transition arrangements are described in the Form 8-K filed with the U.S. Securities and Exchange Commission on April 5, 2018. 

Mr. Jackson resigned from his position as Executive Chairman of the Company effective September 6, 2018.  Mr. Jackson executed a release of claims with the Company as part of his resignation providing him with certain compensation and benefits, as described in the Form 8-K filed with the U.S. Securities and Exchange Commission on September 12, 2018.

On October 15, 2018, Mr. Ismail Dawood was appointed Chief Financial Officer of the Company after previously serving as the Interim Chief Financial Officer and principal financial officer since April 9, 2018, and on January 14, 2019, Mr. John G. Saia joined the Company as Senior Vice President, General Counsel and Corporate Secretary.





28


Item 2. 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 in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would” and similar expressions or variations intended to identify forward-looking statements. Such statements include, but are not limited to, statements concerning market opportunity, our future financial and operating results, investment strategy, sales and marketing strategy, management’s plans, beliefs and objectives for future operations, technology and development, economic and industry trends or tread analysis, expectations about seasonality, opportunities for portfolio purchases, acquisitions, channel partnerships and carrier relationships, use of non-GAAP financial measures, operating expenses, anticipated income tax rates, capital expenditures, cash flows and liquidity. These statements are based on the beliefs and assumptions of our management based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in Part I, Item 1A, “Risk Factors”, of our Annual Report on Form 10-K for the year ended December 31, 2017. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such events.

Overview

We are a leader in administering Consumer-Directed Benefits ("CDBs"), which empower employees to save money on taxes while also providing corporate tax advantages for employers. We are solely dedicated to administering CDBs, including pre-tax spending accounts such as Health Savings Accounts ("HSAs"), health and dependent care Flexible Spending Accounts ("FSAs"), Health Reimbursement Arrangements ("HRAs"), as well as Commuter Benefit Services, including transit and parking programs, wellness programs, Consolidated Omnibus Budget Reconciliation Act ("COBRA"), and other employee benefits in the United States.

We deliver our CDB programs through a highly scalable 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 assist employees and their families in saving money by using pre-tax dollars to pay for certain portions of their healthcare, dependent care, and commuter expenses. Employers financially benefit from our programs through reduced payroll taxes, the benefits of which are realized 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.

Our services are priced 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. In addition, we derive a portion of our revenues from interchange fees that we receive when employee participants use the prepaid debit cards we provide to them for healthcare and commuter expenses.


Critical Accounting Policies and Significant Management Estimates

Other than the adoption of ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)" and ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, there have been no material changes to our critical accounting policies and estimates during the three months ended March 31, 2018, as compared to the critical accounting policies and estimates disclosed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2017.



29


Results of Operations
 
Revenue 

Revenue and changes in revenue by product for the three months ended March 31, 2018 and 2017 were:
 
Three Months Ended March 31,
 
 
 
 
 
2018
 
2017
 
 
 
 
(Dollar in thousands)
Amount
 
Amount
 
$ Change
 
% Change
Revenues:
 
 
 
 
 
 
 
Healthcare
$
75,256

 
$
74,674

 
$
582

 
1
 %
COBRA
28,835

 
28,550

 
285

 
1
 %
Commuter
18,878

 
18,543

 
335

 
2
 %
Other
3,671

 
4,270

 
(599
)
 
(14
)%
Total revenues
$
126,640

 
$
126,037

 
$
603

 
 %

໿
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’ FSAs, HRAs, and HSAs. We also earn interchange revenue paid by financial institutions related to transaction fees on debit cards used by employee participants in connection with all of our healthcare programs and through our wholesale card program and revenue from self-service plan kits called Premium Only Plan kits, or POP revenue.

Healthcare revenue increased by $0.6 million, or 1% for the three months ended March 31, 2018, as compared to the same period in 2017. Healthcare revenue increased due to the addition of new clients and growth in new employee participation for HSA; and an increase in interchange fee and other incentive revenue as a result of a contract renegotiation for our debit card usage.

COBRA Revenue

COBRA revenue is derived from administration services we provide to employer clients for continuation of coverage for participants who are no longer eligible for the employer’s health benefits, such as medical, dental, and vision, and for the continued administration of the employee participants’ HRAs and certain healthcare FSAs.

COBRA revenue increased by $0.3 million, or 1% for the three months ended March 31, 2018, as compared to the same period in 2017. The increase was primarily driven by the revenue associated with annual notice fees.

Commuter Revenue

We derive our commuter revenue from monthly service fees paid by our employer clients, interchange revenue paid by financial institutions related to transaction fees on debit cards used by employee participants in connection with our commuter solutions, and commissions from the sale of transit passes used in our commuter solutions which we purchase from various transit agencies on behalf of employee participants.

Commuter revenue increased by $0.3 million, or 2% for the three months ended March 31, 2018, as compared to the same period in 2017. The increases were primarily due to the addition of new clients and growth in the number of employee participation and an increase in interchange fee revenue.

Other Revenue

Other revenue includes enrollment and eligibility services, employee account administration (i.e., tuition and health club reimbursements), project-related professional fees and other program incentives. 

Other revenue decreased by $0.6 million or 14% for the three months ended March 31, 2018, as compared to the same period in 2017. The decrease was primarily due to a decrease in revenue from enrollment and eligibility services.

Cost of Revenues

30


 
 
Three Months Ended March 31,
 
 
 
 
(Dollar in thousands)
 
2018
 
2017
 
$ Change
 
% Change
Cost of revenues (excluding amortization of internal use software)
 
$
45,242

 
$
48,088

 
$
(2,846
)
 
(6
)%
Percentage of revenue
 
36
%
 
38
%
 
 
 
 

Cost of revenues consist of direct expenses for claims processing, product support, and customer service personnel, outsourced and temporary labor, check/ACH payment processing services, debit card processing services, shipping and handling, passes, and employee participant communications.

Cost of revenues decreased by $2.8 million or 6% for the three months ended March 31, 2018, as compared to the same period in 2017. The decrease was primarily due to a decrease in compensation and related benefits associated with the headcount vacancy.

As we grow organically and through portfolio purchases, acquisitions, and channel partner arrangements, 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, acquisitions and channel partner arrangements. Prior to migrating to our proprietary technology platforms, new portfolios often operate with higher service delivery costs that result in increased cost of revenues until we are able to complete the migration process which is targeted to occur within 12 to 24 months of the portfolio acquisition date.

Operating Expenses

Technology and Development
 
 
Three Months Ended March 31,
 
 
 
 
(Dollar in thousands)
 
2018
 
2017
 
$ Change
 
% Change
Technology and development
 
$
13,033

 
$
15,271

 
$
(2,238
)
 
(15
)%
Percentage of revenue
 
10
%
 
12
%
 
 
 
 

໿
Technology and development expenses consist of personnel and related expenses, outsourced programming services, on-demand technology infrastructure, and expenses associated with equipment and software development and licenses.

Technology and development expenses decreased by $2.2 million, or 15% for the three months ended March 31, 2018, as compared to the same period in 2017. The decrease in technology & development of approximately is primarily attributable to data center migration costs associated with the ADP TSA agreement that was completed in 2017.

We intend to continue enhancing 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. The timing of development and enhancement projects, including the nature of expenditures as well as the phase of the project that could require capitalization or expense treatment, will significantly affect our technology and development expense both in dollar amount and as a percentage of revenues.  

Sales and Marketing
 
 
Three Months Ended March 31,
 
 
 
 
(Dollar in thousands)
 
2018
 
2017
 
$ Change
 
% Change
Sales and marketing
 
$
18,338

 
$
16,079

 
$
2,259

 
14
%
Percentage of revenue
 
14
%
 
13
%
 
 
 
 

Sales and marketing expenses consist primarily of compensation and related expenses for our sales, client services, and marketing staff, including sales commissions for our direct sales force and external agent/broker commission expense, as well as communication, promotional, public relations, and other marketing expenses.

Sales and marketing expenses increased by $2.3 million or 14% for the three months ended March 31, 2018, as compared to the same period in 2017. The increase was primarily due to an increase in compensation and related benefit costs, and direct and outside sales commissions associated with overall growth in revenue.

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

General and Administrative
 
 
Three Months Ended March 31,
 
 
 
 
(Dollar in thousands)
 
2018
 
2017
 
$ Change
 
% Change
General and administrative
 
$
25,249

 
$
13,500

 
$
11,749

 
87
%
Percentage of revenue
 
20
%
 
11
%
 
 
 
 

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

General and administrative expenses increased by $11.7 million or 87% for the three months ended March 31, 2018, as compared to the same period in 2017. The increase was primarily due to increase in professional fees related to legal and accounting fees attributed to the restatement and audit committee investigations.

Amortization
 
 
Three Months Ended March 31,
 
 
 
 
(Dollar in thousands)
 
2018
 
2017
 
$ Change
 
% Change
Amortization
 
$
9,991

 
$
9,237

 
$
754

 
8
%
Percentage of revenue
 
8
%
 
7
%
 
 
 
 

Our amortization charge consists of two components: amortization of internal use software and amortization of acquired intangible assets. We capitalize our software development costs related to the development and enhancement of our business solutions. 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. Acquisition-related intangible assets are also amortized over their estimated useful lives.  
Amortization increased by $0.8 million or 8% for the three months ended March 31, 2018 as compared to the same periods in 2017. The increase in the three months ended March 31, 2018 was primarily driven by an increase in amortization resulting from the acquired intangibles from the Tango acquisition and an increase in amortization of internal use software due to increased investment in software development projects.

Employee Termination and Other Charges
 
 
Three Months Ended March 31,
 
 
 
 
(Dollar in thousands)
 
2018
 
2017
 
$ Change
 
% Change
Employee termination and other charges
 
$

 
$
731

 
$
(731
)
 
(100
)%
Percentage of revenue
 
%
 
1
%
 
 
 
 

Employee termination and other charges decreased by $0.7 million for the three months ended March 31, 2018 as compared to the same period in 2017, and is primarily attributable to headcount reduction that took place in the first quarter of 2017.

Other Income (Expense), net
 
 
Three Months Ended March 31,
 
 
 
 
(Dollar in thousands)
 
2018
 
2017
 
$ Change
 
% Change
Interest income
 
$
1,271

 
$
67

 
$
1,204

 
1,797
 %
Interest expense
 
$
(2,182
)
 
$
(1,436
)
 
$
(746
)
 
52
 %
Other income (expense), net
 
$
(5
)
 
$
(221
)
 
$
216

 
(98
)%


32


Interest income increased by $1.2 million for the three months ended March 31, 2018 as compared to the same period in 2017. The increase in interest income is attributable to the increase in investments as a result of our investment strategy implemented during the third quarter of 2017.

Interest expense increased by $0.7 million or 52% for the three months ended March 31, 2018, as compared to the same period in 2017. Increase in interest expense is primarily due to a higher interest accrual.

Other income (expense), net decreased by $0.2 million the three months ended March 31, 2018, as compared to the same periods in 2017, primarily due to a one-time loss in our share of an equity investment.

Income Taxes
 
 
Three Months Ended March 31,
 
 
 
 
(Dollar in thousands)
 
2018
 
2017
 
$ Change
 
% Change
Income before income taxes
 
$
13,871

 
$
21,541

 
 
 
 
Income tax provision
 
(2,852
)
 
$
(5,484
)
 
$
2,632

 
(48
)%
Effective tax rate
 
21
%
 
25
%
 
 
 
 

 Income tax provision decreased by $2.6 million or 48% for the three months ended March 31, 2018 as compared to the same period in 2017, due to decrease in income before tax and effect of the change in tax rate from 35% to 21% as part of the Tax Act.


33


Liquidity and Capital Resources

As of March 31, 2018, our principal sources of liquidity were cash and cash equivalents totaling $691.3 million and short-term investments totaling $260.0 million comprised primarily of funding by clients of amounts to be paid on behalf of employee participants, public stock offerings and cash generated from ongoing operations.

We believe that our existing cash and cash equivalents, short-term investments, and the available credit from our revolving credit facility will be sufficient to meet our working capital, debt, capital expenditures, and stock repurchase needs, as well as anticipated cash requirements for potential future portfolio purchases over at least the next 12 months. 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 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 employer clients, we receive prefunds that have been and are expected to continue to be a significant source of cash flows from operating activities. Our client contracts do not contain restrictions on our use of client prefunds and, as a result, each prefund is reflected in cash and cash equivalents on our consolidated balance sheet with an equivalent customer obligation recorded as a liability as the prefund is received. Changes in these prefunds and the corresponding customer obligations are reflected in our cash flows 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.

The operation of these prefunds for our 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 and other factors. 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, the replenishment occurs 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 and the date payment is received from our employer clients for reimbursement of payments we have made on behalf of employee participants.

Revolving Credit Facility (Credit Agreement)

On April 4, 2017, we entered into a Second Amended and Restated Credit Agreement with MUFG Union Bank, N.A., as administrative agent, to increase the borrowing capacity to $400.0 million, with a $15.0 million letter of credit subfacility (the "Credit Agreement"). The Credit Agreement contains an increase option permitting us, subject to certain conditions and requirements, to arrange with existing lenders and/or new lenders to provide up to an aggregate of $100 million in additional commitments. The loans bear interest, at our option, at either (i) a London Interbank Offered Rate (LIBOR) determined in accordance with the Credit Agreement, plus a margin ranging from 1.25% to 2.25%, or (ii) a base rate determined in accordance with the Credit Agreement, plus a margin ranging from 0.25% to 1.25%, in either case with such margin determined based on our consolidated leverage ratio for the preceding four fiscal quarter period. Interest is due and payable in arrears quarterly for base rate loans and at the end of an interest period for LIBOR rate loans. Principal, together with all accrued and unpaid interest, is due and payable on April 4, 2022. Our obligations under the Credit Agreement are secured by substantially all of our assets. We elected option (i) and, as of March 31, 2018, the interest rate applicable to the revolving credit facility was 3.24%. All of our existing and future material subsidiaries are required to guarantee our obligations under the Credit Agreement. The guarantees by future material subsidiaries are and will be secured by substantially all of the assets of such subsidiaries. As of March 31, 2018, we have $150.2 million available to borrow under the revolving credit facility. We are currently in compliance with all financial and non-financial covenants under the credit facility.

On April 5, 2018, our Board concluded the previously issued financial statements for (i) the quarterly periods ended September 30, June 30 and March 31, 2017, (ii) the annual period ended December 31, 2016 and (iii) the quarterly periods ended September 30 and June 30, 2016 should be restated and should no longer be relied upon. Consequently, we did not meet our obligation to provide our financial statements to the Agent by the contractual delivery date. In March 2018, we entered into a Reporting Extension Agreement (the “Extension Agreement”), by and among the Company, the lenders party thereto and MUFG Union Bank, N.A.,

34


as administrative agent to extend the time period for delivery to Agent and the lenders our delinquent financial statements to June 30, 2018. In June 2018, we entered into a Second Reporting Extension Agreement and paid the Agent $0.8 million to extend the delivery date of our delinquent financial statements to March 16, 2019. In March 2019, the Company entered into a Third Reporting Extension Agreement and paid the Agent $0.1 million to extend the delivery date of any remaining delinquent financial statements to May 10, 2019.

Cash Flows

The following table presents information regarding our cash flow activities:
 
Three Months Ended March 31,
(in thousands)
2018
 
2017
Net cash used in operating activities
$
(16,874
)
 
(53,791
)
Net cash used in investing activities
(73,102
)
 
(5,973
)
Net cash provided by (used in) financing activities
1,972

 
(2,418
)
Net decrease in cash and cash equivalents, unrestricted and restricted
$
(88,004
)
 
$
(62,182
)


Cash Flows from Operating Activities

໿
໿
Net cash used in operating activities was $16.9 million for the three months ended March 31, 2018 and was primarily driven by a decrease in customer obligations primarily from higher FSA disbursements as compared to FSA invoicing during the quarter, an increase in accounts receivable, partly due to FSA claim seasonality and an increase in accounts payable and accrued expenses due to timing of payments.

The non-cash items consisted mainly of amortization from acquired intangibles and stock-based compensation expense due to an increase in headcount and higher attainment of metrics from performance-based restricted stock units.

Cash Flows from Investing Activities
໿

Net cash used in investing activities was $73.1 million for the three months ended March 31, 2018, primarily due to $65.4 million net purchases of available-for-sale investments, $7.6 million investment in capital expenditures.

Cash Flows from Financing Activities

໿
໿
Net cash provided by financing activities was $2.0 million for the three months ended March 31, 2018 which consisted of approximately $2.3 million in proceeds from exercises of stock options and sale of stock under the 2012 Employee Stock Purchase Plan (“ESPP”), offset by a $0.2 million payment of taxes related to net share settlement of stock-based compensation arrangements.



35


Contractual Obligations

The following table summarizes our significant contractual obligations as of March 31, 2018:
(in thousands)
Total
 
Less than
1 year
 
1-3
years
 
3-5
years
 
More than
5 years
Long-term debt obligations (1)
$
247,000

 
$

 
$

 
$
247,000

 
$

Interest on long-term debt obligations (2)
32,540

 
8,002

 
16,003

 
8,535

 

Operating lease obligations (3)
50,308

 
9,208

 
19,363

 
14,984

 
6,753

Total
$
329,848

 
$
17,210

 
$
35,366

 
$
270,519

 
$
6,753

 

______________________________________________________________________________
(1)
As of March 31, 2018, maximum borrowings under the revolving credit facility are $400.0 million with a base rate determined in accordance with the credit agreement or, at our option, LIBOR plus a spread of 1.25% to 2.25% per annum, and a maturity date of April 4, 2022. As of March 31, 2018, our outstanding principal of $247.0 million is presented net of debt issuance costs on our condensed consolidated balance sheets. The debt issuance costs are not included in the table above.
(2)
Estimated interest payments assume the interest rate applicable as of March 31, 2018 of 3.24% per annum on a $247.0 million outstanding principal amount.
(3)
We lease facilities under non-cancelable operating leases expiring at various dates through 2028.


Off-Balance Sheet Arrangements

Other than outstanding letters of credit issued under our revolving credit facility, we do not have any off-balance sheet arrangements. The majority of the standby letters of credit mature in one year. However, in the ordinary course of business, we will continue to renew or modify the terms of the letters of credit to support business requirements. The letters of credit are contingent liabilities, supported by our revolving credit facility, and are not reflected on our condensed consolidated balance sheets.


Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in our market risk during the three months ended March 31, 2018.  For additional information, see Part II, Item 7A., “Quantitative and Qualitative Disclosures About Market Risk”, of our Annual Report on Form 10-K for the year ended December 31, 2017.  


Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report on Form 10-Q. The term “disclosure controls and procedures” means our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Based on the foregoing evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2018, due to the existence of unremediated material weaknesses in the Company’s internal control over financial reporting as described below, the Company’s disclosure controls and procedures were not effective.

Notwithstanding the existence of the material weaknesses described below, management believes that the consolidated financial statements and related financial information included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows as of and for the periods presented, in conformity with the generally accepted accounting principles in the United States of America ("GAAP"). Management’s belief is based on a number of factors, including, but not limited to:


36


a.
the completion of the Audit Committee’s investigation and the substantial resources expended (including the use of external consultants and experts) to respond to the findings and the resulting restatement of certain of our previously issued financial statements; the Audit Committee engaged independent professionals to assist its investigation throughout the process and, the Audit Committee has concluded its investigation;
b.
our internal review that identified certain accounting errors and control deficiencies, leading to the restatement of certain of our previously issued financial statements for the quarterly periods ended June 30, 2016, September 30, 2016, financial year ended December 31,2016, and the quarterly periods ended March 31, 2017, June 30, 2017 and September 30, 2017;
c.
based on the efforts in (a) and (b) above, we have updated, and in some cases corrected, our accounting policies and have applied these to our previously issued financial results and to our fiscal year 2016 and 2017 financial results; and
d.
certain remediation actions we have undertaken to address the identified material weaknesses, as discussed below.

Management’s Report on Internal Control over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act. Our internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and overseen by our Board of Directors (the “Board”), management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures included in such controls may deteriorate.
Our management has assessed the effectiveness of our internal control over financial reporting as of March 31, 2018. In making this assessment, management used the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. Based on the results of that evaluation, which included information identified during the Audit Committee investigation and the work undertaken by management and the Company's advisors, management has concluded that our internal control over financial reporting as of March 31, 2018 was not effective due to the existence of the following material weaknesses in internal control over financial reporting described below.
Control Environment, Risk Assessment, Control Activities and Monitoring
Based on the investigations conducted under the direction of the Audit Committee of the Board, it was concluded that there was an inadequate open flow, transparency, communication and dissemination of relevant and pertinent information from former senior management concerning a complex transaction with the federal government that contributed to an ineffective control environment driven by the tone at the top. Management’s failure to timely communicate all pertinent information resulted in an environment which led to an error in the financial statement as of the end of the period covered by this report.
In addition, we did not maintain effective internal control over financial reporting related to the following areas: control environment, risk assessment, control activities and monitoring:
We did not have processes and controls to ensure there were adequate mechanisms and oversight to ensure accountability for the performance of internal control over financial reporting responsibilities and to ensure corrective actions were appropriately prioritized and implemented in a timely manner.
We did not effectively execute a strategy to attract, develop and retain a sufficient complement of qualified resources with an appropriate level of knowledge, experience, and training in certain areas important to financial reporting.
There was not an adequate assessment of changes in risks by management that could significantly impact internal control over financial reporting or an adequate determination and prioritization of how those risks should be managed.

37


We did not have adequate management oversight of accounting and financial reporting activities in implementing certain accounting practices to conform to the Company’s policies and GAAP.
We did not have adequate management oversight around completeness and accuracy of data material to financial reporting.
There was a lack of robust, established and documented accounting policies and insufficiently detailed Company procedures to put these policies into effective action.
We were not focused on a commitment to competency as it relates to creating priorities, allocating adequate resources and establishing cross functional procedures around managing complex contracts and non-routine transactions as well as managing change and attracting, developing and retaining qualified resources.

These deficiencies in our internal control over financial reporting contributed to the following identified material weaknesses:

A.
Accounting Close and Financial Reporting

We had inadequate or ineffective process level and monitoring controls in the area of accounting close and financial reporting specifically, but not exclusively, around the review of account reconciliations, account estimates and related cut-off, and monitoring of the accounting close cycle. We also did not have effective business processes and controls to conduct an effective review of manual data feeds into journal entries for divisions which were not integrated with the main ERP system.

We did not have robust, established and documented accounting policies that were implemented effectively, which led to adjustments in areas such as, but not exclusive to Impairment of Internally Developed Software (IDS) and Unclaimed Liability. As a result of these adjustments the accounts related to Amortization of IDS, Fixed Assets, and operating expenses as they relate to interest and penalties were impacted.

We also did not have a robust process around managing change and corresponding assessment and implementation of Accounting Policies. This resulted in a reevaluation of the Accounts Receivable and Customer Obligation Offset Policy of the organization. Furthermore, it also resulted in the delayed assessment and design of controls for the timely implementation of controls around Accounting Standard 606 (ASC 606) for Revenue Recognition which is effective January 2018. These gaps resulted in several adjustments in the consolidated financial statements as of the end of the period covered by this report.

B.
Contract to Cash Process

We did not have effective controls around our contract-to-cash life cycle. The root cause of these gaps were due to inadequate or ineffective process level controls around billing set-up during customer implementation, managing change to existing customer billing terms and conditions, timely termination of customers, implementing complex and/or non-standard billing arrangements which require manual intervention or manual controls for billing to customers, processing timely adjustments, lack of robust, established and documented policies to assess collectability and reserve for revenue, bad debts and accounts receivable, and availability of customer contracts.
These gaps resulted in several adjustments in Revenue, Accounts Receivable, and Accounts Receivable Reserves in the consolidated financial statements as of the end of the period covered by this report.

C.
Risk Assessment and Management of Change

We did not maintain an effective risk assessment and monitoring process to manage the expansion of our existing business. Hence, there were inadequate and ineffective business and financial reporting control activities associated with change and growth in the business. Amongst other areas, the assessment of the control environment and the design of manual controls around financial system implementations, such as NetSuite, was not performed adequately in 2017.
As a result, the Company did not properly estimate and record certain transactions which resulted in errors in the consolidated financial statements as of the end of the period covered by this report

D.
Review of New, Unusual or Significant Transactions and Contracts


38


We did not have adequate risk assessment controls to continuously formally assess the financial reporting risks associated with executing new, significant or unusual transactions, contracts or business initiatives. As a result, the Company did not adequately identify and analyze changes in the business and hence implement effective process level controls and monitoring controls that were responsive to these changes and aligned with financial reporting objectives. This failure to identify and analyze changes occurred in connection with the integration of acquisitions and the monitoring and recording of certain revenues associated with a complex government contra