HealthEquity, Inc. — Q3 FY2017 Form 10-Q
Reporting period: Quarter and nine months ended October 31, 2016; comparisons are with the corresponding 2015 periods. HealthEquity provides technology-enabled services for HSAs and other healthcare accounts. Figures below are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and key operating metrics
Revenue comes primarily from service fees, interest and recordkeeping fees on custodial assets, and payment-card interchange. Growth reflects expansion among existing and new network partners, increased member activity, and HSA portfolio acquisitions completed in the prior fiscal year.
- HSA members were 2.38 million at October 31, up 48% year over year; members with investments were 58,226, up 43%.
- Total assets under management were $4.28 billion, up 59% year over year, including $3.71 billion of cash AUM and $571 million of investment AUM.
- Management reported 25 of the 50 largest U.S. health plans as partners and more than 33,000 employer clients.
Financial performance
| Metric | Three months ended Oct. 31, 2016 | Year-over-year change | Nine months ended Oct. 31, 2016 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $43.4 million | +42% | $131.6 million | +45% |
| Gross profit / margin | $25.9 million / 60% | Margin: 58% prior year | $82.1 million / 62% | Margin: 60% prior year |
| Operating income / margin | $9.0 million / 21% | Operating income +43% | $35.0 million / 27% | Operating income +61% |
| Net income | $6.0 million | +47%; diluted EPS $0.10 vs. $0.07 | $22.3 million | +65%; diluted EPS $0.37 vs. $0.23 |
| Adjusted EBITDA, non-GAAP | $14.5 million; 34% of revenue | +47% | $51.0 million; 39% of revenue | +60% |
Quarterly revenue by source was service $18.8 million (+24%), custodial $15.0 million (+64%), and interchange $9.6 million (+55%). Nine-month revenue was service $56.6 million (+27%), custodial $43.6 million (+64%), and interchange $31.4 million (+59%). Service revenue per HSA member declined approximately 17% for the quarter and 15% year to date, partly reflecting tiered pricing; higher custodial and interchange revenue per member partly offset the decrease.
Cash flow and liquidity: Nine-month operating cash flow was $31.0 million, compared with $18.8 million a year earlier. Investing activities used $9.8 million versus $81.2 million, which included significant prior-year portfolio acquisition and marketable-security purchases. Financing activities provided $20.5 million, mainly from option exercises and related tax benefits. Cash and cash equivalents ended at $125.3 million; cash, cash equivalents, and marketable securities totaled $165.7 million, versus $123.8 million at January 31, 2016.
Balance sheet and debt: Total assets were $264.5 million and total liabilities $11.9 million at October 31. The company had no borrowings under its $100 million secured revolving credit facility and was in compliance with its covenants. The facility requires leverage and interest-coverage ratios of at least / no more than 3.00-to-1.00, as applicable.
Material changes and notable items
- Revenue growth was led by custodial revenue, supported by average daily cash AUM growth of 62% in the quarter and a slight increase in cash yield to 1.57% from 1.55%.
- Cost of revenue rose 36% in the quarter and operating expenses rose 48%, reflecting greater servicing volume, hiring, technology investment, and higher acquired-intangible amortization. Service costs per HSA member declined 9% for the quarter and 12% year to date, which management attributed to scale and efficiency.
- The company recorded $595,000 of acquisition-related expense during the nine-month period and $237,000 of expenses related to a secondary offering of shares by existing stockholders in the quarter.
- The effective tax rate was 31.6% for the quarter and 34.6% year to date, down from 36.4% and 36.6%, respectively, primarily due to research and development tax credits. Option-related tax benefits contributed $15.9 million to financing cash flow for the nine months.
- A lease amendment expanded office space under a lease running through March 31, 2027, with initial annual base rent of approximately $569,000 and 2.5% annual increases.
Outlook, risks, and contingencies
Management expects near-term annual gross margin to remain relatively steady, while sales and marketing, technology and development, and general and administrative expenses are expected to increase in dollars as the business grows. The company expects higher capital expenditures for the remainder of FY2017 to upgrade its platform architecture and functionality and to support expanded office space. Management stated existing cash, equivalents, and marketable securities should cover operating and capital needs for at least 12 months. No numerical revenue or earnings guidance was provided.
Key risks discussed include dependence on U.S. HSA adoption and favorable tax treatment, healthcare regulation, partner and member growth, competition, data/privacy and regulatory requirements, and interest rates. A sustained decline in prevailing rates could pressure custodial revenue, although partner diversification and contract terms mitigate short-term exposure. Cash and marketable securities totaled $165.7 million, of which $750,000 was covered by federal deposit insurance. The filing reports no material change in previously disclosed risk factors and no litigation expected to have a material adverse effect. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether member and AUM growth continues, and how much growth is attributable to acquired portfolios versus organic partner additions and existing-member balances.
- Whether cash yields and custodial revenue remain resilient as interest rates and bank-partner contracts change.
- Whether service revenue per member continues to decline and interchange growth and service-cost efficiencies offset that pressure.
- Execution, timing, and returns on platform investment and planned capital expenditures, alongside rising operating expenses and acquired-intangible amortization.
- The cash-flow impact and accounting treatment of employee stock-option tax benefits, and the company’s liquidity and covenant position.
- Long-term cost commitments under the expanded office lease and any future acquisition-related expenses.