HealthEquity, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended October 31, 2019. Amounts below are U.S. dollars unless stated otherwise. WageWorks results are consolidated only from its August 30, 2019 acquisition; the quarter includes approximately two months of WageWorks operations.
Business context
HealthEquity administers health savings accounts (HSAs) and complementary consumer-directed benefits (CDBs). At quarter-end it administered 5.0 million HSAs, 7.5 million CDBs and 12.5 million total accounts, with $10.5 billion in HSA assets. The WageWorks acquisition expanded its employer distribution and benefits offerings, including FSAs, HRAs, COBRA and commuter benefits.
Financial and operating metrics
| Metric | Three months ended October 31, 2019 | Nine months ended October 31, 2019 | Comparable 2018 period |
|---|---|---|---|
| Revenue | $157.1 million | $330.8 million | $70.5 million; $211.5 million |
| Gross profit / gross margin | $96.0 million / 61.1% | $212.2 million / 64.2% | $45.8 million / 65.0%; $136.7 million / 64.7% |
| Income from operations | $9.9 million | $62.5 million | $19.0 million; $61.1 million |
| Net income (loss) | $(21.3) million | $39.9 million | $15.7 million; $60.8 million |
| Diluted EPS | $(0.30) | $0.59 | $0.25; $0.96 |
| Adjusted EBITDA, non-GAAP | $55.5 million; 35% of revenue | $135.1 million; 41% of revenue | $29.7 million; 42%; $91.1 million; 43% |
| Operating cash flow | Not provided for the quarter | $74.1 million | $80.8 million for nine months |
Quarterly revenue rose 123% and nine-month revenue rose 56%, primarily reflecting WageWorks. Nine-month growth also reflected higher HSA balances and custodial yields. Gross margin declined year over year in both comparisons. The quarterly loss reflected acquisition costs, merger integration expenses, acquired-intangible amortization, and interest expense; the filing reports $38.5 million of acquisition and integration expenses, net of tax, for the quarter. Nine-month net income declined despite higher revenue.
For the nine months, investing cash outflow was $1.715 billion, primarily due to $1.630 billion of acquisition spending, net of cash acquired. Financing cash inflow was $1.454 billion, including debt and equity proceeds. Cash and cash equivalents were $174.6 million at October 31, down from $361.5 million at January 31. The company reported $1.25 billion of term-loan principal outstanding, or $1.227 billion net of issuance costs, and no revolver borrowings; the revolving facility provides up to $350 million. The term loan carried a variable rate of 4.12% at quarter-end. The company was in compliance with debt covenants.
Material changes versus prior periods
- WageWorks was acquired for approximately $2.0 billion in cash to its stockholders. Total acquisition consideration for accounting purposes was $2.122 billion, including the fair value of the prior WageWorks investment and acquisition-related equity awards.
- The acquisition added substantial goodwill and intangible assets. At October 31, goodwill was $1.335 billion and net intangible assets were $796.2 million; together they represented approximately 83% of total assets.
- Revenue growth was acquisition-led: service revenue increased 250% for the quarter and 88% for nine months; custodial revenue increased 49% and 46%; interchange revenue increased 62% and 25%, respectively.
- Debt, interest expense, acquisition and integration costs, and amortization of acquired intangibles increased significantly. Nine-month operating cash flow decreased from $80.8 million to $74.1 million.
- The company completed a follow-on offering of 7,762,500 shares in July 2019 and received approximately $458.5 million net proceeds.
Outlook, commentary and risks
- Management estimated approximately $50 million of annualized ongoing net synergies by the end of fiscal 2021 and $80 million to $100 million of non-recurring integration costs over 24 to 36 months after closing. It anticipated longer-term revenue synergies. These are estimates, not guaranteed outcomes.
- Management stated cash and cash equivalents should fund operating and capital expenditure needs for at least the next 12 months. It expected capital expenditures to increase for the remainder of fiscal 2020, particularly for technology and office improvements. The filing provides no specific revenue or earnings guidance.
- WageWorks had previously identified material weaknesses in financial reporting controls, including accounting close and reporting, contract-to-cash processes, transaction review, reconciliations and IT controls. HealthEquity was assessing remediation; its controls evaluation excluded portions of WageWorks’ controls. Management said HealthEquity’s disclosure controls were effective at the reasonable assurance level subject to that exclusion.
- WageWorks-related securities and derivative litigation, an SEC investigation and a U.S. Attorney’s Office investigation remained ongoing. The company said losses were not considered probable or reasonably estimable, while noting an adverse outcome could materially affect results, liquidity or cash flows.
- Key risks include integration execution and client attrition, remediation of controls, potential acquired liabilities, goodwill or intangible impairment, data security and service continuity, changes to tax or healthcare regulation, and reliance on interest income and payment-card usage. A 1 percentage-point increase in borrowing rates was estimated to add approximately $12.6 million of interest expense over the next 12 months.
Important facts for investors to verify
- Progress toward the $50 million synergy target, actual integration spending, platform migration results and client retention.
- Remediation of WageWorks’ material control weaknesses and the scope of future control assessments.
- Debt repayment, variable-rate exposure, covenant headroom and the availability of the $350 million revolver.
- Whether acquired goodwill and intangible-asset valuations are finalized within the measurement period, and whether impairment indicators arise.
- Developments in WageWorks-related litigation and government investigations, and any resulting costs or liabilities.
- Underlying performance apart from acquisition effects, including revenue per account, custodial yields, gross margins and operating cash flow.