HealthEquity, Inc. — Form 10-Q summary
Reporting period: Three and six months ended July 31, 2019; financial statements are unaudited. HealthEquity provides technology-enabled health savings and consumer-directed benefits services. The company reported 4.16 million HSA members and $8.52 billion in custodial assets at period-end.
Financial performance
| Metric | Three months ended July 31, 2019 | Six months ended July 31, 2019 |
|---|---|---|
| Revenue | $86.6 million, up 22% | $173.7 million, up 23% |
| Gross profit / margin | $58.4 million / approximately 67.5% | $116.2 million / approximately 66.9% |
| Operating income | $24.9 million | $52.5 million |
| Net income | $19.4 million, down 14% | $61.2 million, up 36% |
| Diluted EPS | $0.30, versus $0.36 | $0.94, versus $0.72 |
| Adjusted EBITDA | $40.6 million, up 28%; 47% of revenue | $79.6 million, up 30%; 46% of revenue |
| Operating cash flow | $56.8 million for the six months, versus $52.6 million |
For the quarter, service revenue rose 5% to $26.3 million, custodial revenue rose 42% to $43.6 million, and interchange revenue rose 8% to $16.7 million. Custodial growth reflected higher average cash balances and yield: average custodial cash was up 17%, and yield increased to 2.54% from 2.11%. Service and interchange revenue per average HSA member declined approximately 10% and 7%, respectively.
Quarterly net income decreased despite higher operating income, mainly because the income tax provision increased and other expense worsened. For the six-month period, net income benefited materially from a $27.3 million unrealized gain on WageWorks shares; this gain is not recurring and the investment was canceled when the merger closed.
Balance sheet, cash flow and financing
At July 31, cash and cash equivalents were $815.2 million, total assets $1.10 billion, total liabilities $81.3 million, and stockholders’ equity $1.02 billion. There was no borrowing under the prior $100 million revolving facility. Cash increased by $453.7 million during the six months, primarily reflecting $458.9 million of net proceeds from a July follow-on equity offering; investing activities used $68.6 million, including $53.8 million to purchase WageWorks shares. The company reported $13.0 million of capital expenditures for the six months.
Subsequent to quarter-end, on August 30, HealthEquity completed its approximately $2.0 billion all-cash acquisition of WageWorks, funded with approximately $805.4 million of cash and approximately $1.22 billion of net term-loan borrowings. It entered a five-year credit agreement comprising a $1.25 billion senior secured term loan and a $350 million revolving facility. The debt bears floating rates, is secured by substantially all company and guarantor assets, and carries leverage and interest-coverage covenants. These post-quarter transactions are not reflected in the July 31 balance sheet.
Material changes, outlook and risks
- HSA members increased 16% year over year to 4.16 million; custodial assets grew 21% to $8.52 billion. Members with investments rose 31% to 187,000.
- Operating expenses rose 34% for the quarter, including $2.8 million of merger-integration costs. Management expects integration expenses to continue for 24–36 months.
- Management expects the WageWorks combination to expand employer and benefits-advisor distribution and add complementary benefits products. It also expects the merger to materially affect revenue, expenses, assets and other financial results; quantified guidance is not provided in the filing text.
- Management anticipated higher capital expenditures for the remainder of fiscal 2020 to support platform improvements and office needs. Its stated view that available cash would cover operating and capital requirements for at least 12 months should be considered alongside the subsequent acquisition financing and cash use.
- Key risks include integration execution, realization of anticipated synergies, inherited WageWorks liabilities and legal proceedings (including referenced class-action and derivative litigation and an SEC investigation), and the combined company’s ability to maintain effective financial controls. Debt covenants and floating interest rates add financial risk. The business is also exposed to interest-rate changes, healthcare-policy and regulatory changes, competition, and seasonal costs.
- The company said its disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. It reported no HealthEquity litigation expected to have a material adverse effect as of July 31, while noting it was evaluating WageWorks proceedings after closing.
Important facts for investors to verify
- Post-acquisition debt outstanding, cash balance, interest cost, covenant headroom and compliance under the new credit agreement.
- WageWorks integration progress, actual synergy realization, integration spending, and the outcome or exposure from inherited legal matters and the SEC investigation.
- Whether custodial revenue growth and yields can persist if market interest rates decline, and how the company adjusts interest credited to members.
- Underlying earnings excluding the $27.3 million unrealized WageWorks gain, acquisition costs and merger-integration expenses; also monitor tax-rate changes and dilution from equity awards.
- Conversion of the acquired HSA portfolio expected in October 2019, and execution of planned platform and capital investments.