HealthEquity, Inc. — Q2 FY2018 Form 10-Q
Business and reporting period: The filing covers the quarter and six months ended July 31, 2017. HealthEquity provides technology-enabled administration and custodial services for HSAs and other healthcare accounts. It reported 2.90 million HSA members, up 26% year over year, and served 87 health plans and more than 34,000 employer clients.
Financial results
| Metric | Three months ended July 31, 2017 | Six months ended July 31, 2017 | Year-over-year change |
|---|---|---|---|
| Revenue | $56.9 million | $112.3 million | +29%; +27% |
| Gross profit / margin | $35.8 million / 63.0% | $69.5 million / 61.9% | Margin: 64.6% / 63.8% in 2016 |
| Operating income / margin | $16.5 million / 29.0% | $32.4 million / 28.9% | Income +29%; +25% |
| Net income / diluted EPS | $16.9 million / $0.27 | $31.0 million / $0.50 | Net income +106%; +90% |
| Adjusted EBITDA / margin | $23.9 million / 42% | $46.4 million / 41% | +30%; +27%; margins unchanged |
| Operating cash flow | Not presented quarterly | $39.8 million | $15.5 million in 2016 |
- Quarterly revenue growth comprised service revenue of $22.8 million (+21%), custodial revenue of $21.3 million (+44%), and interchange revenue of $12.8 million (+21%). Six-month revenue by category was $45.3 million, $40.6 million, and $26.4 million, respectively.
- Quarterly custodial revenue benefited from average daily custodial cash growth of 23% and yield rising to 1.83% from 1.58%. Service revenue per HSA member declined about 4% in the quarter as partner pricing tiers lower per-account fees at higher membership levels.
- Cash, cash equivalents and marketable securities totaled $210.3 million at July 31, versus $180.4 million at January 31. Cash and cash equivalents alone were $169.7 million. Current assets were $239.6 million and current liabilities $12.9 million.
- Six-month investing cash outflow was $17.1 million, including $6.5 million for HSA portfolio rights, $3.0 million for the BenefitGuard business, and $5.2 million for software and capitalized development. Financing cash inflow was $7.1 million, primarily stock-option exercises. Cash increased $29.8 million.
- No borrowings were outstanding under the $100 million revolving credit facility; the company reported covenant compliance. Total liabilities were $15.0 million. The facility is secured, includes leverage and interest-coverage tests, and expires in September 2020.
Material changes, outlook and risks
- Revenue and member growth were accompanied by higher service costs, which rose 42% in the quarter; service costs per HSA member increased 13%, partly due to fraud-prevention measures. Management expects annual gross margin to remain relatively steady near term.
- Management expects sales and marketing, technology and development, and general and administrative expenses to rise in dollars as the business grows. Capital expenditures are expected to increase in the remainder of FY2018, particularly for platform architecture and office improvements. Management stated existing liquidity should cover operating and capital needs for at least 12 months. No specific revenue or earnings guidance was provided.
- Custodial cash assets were $4.50 billion and total custodial assets $5.37 billion, up 23% and 28%, respectively, year over year. These are member assets held in custody, not corporate cash. Revenue remains exposed to interest-rate changes, contract renewals, healthcare-market conditions, and regulatory changes.
- The company received U.S. Treasury designation on July 24, 2017 to act as both a passive and non-passive non-bank custodian, allowing discretion to direct investments. It must satisfy specified net-worth thresholds relative to custodial funds to accept additional assets.
- The quarter included a $6.8 million HSA portfolio acquisition and a $3.0 million acquisition of BenefitGuard assets, with immaterial reported operating impact. On August 3, 2017, the company acquired sole-custodian rights to another HSA portfolio for $3.3 million.
- Adoption of ASU 2016-09 led to stock-compensation tax benefits of $6.6 million for the quarter and $10.5 million for the six months, materially reducing the effective tax rate. The quarter recorded a $0.5 million income-tax benefit versus a $4.5 million provision in the prior-year quarter. Management cautions that the tax-rate comparison reflects this accounting change.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. No material litigation or material changes to previously disclosed risk factors were reported. Other key risks include competition, data security and privacy, dependence on healthcare-related accounts, and interest-rate sensitivity.
Investor facts to verify
- Whether membership growth and custodial cash yields persist, and whether service-fee tiering or higher service costs constrain margins.
- Acquisition integration, portfolio-member transitions, and the effect of the new non-passive custodial designation and its capital requirements.
- How much reported earnings growth reflects operating performance versus stock-compensation tax benefits, and the future effective tax rate.
- Progress and returns on platform investment, planned capital spending, and compliance with the credit facility’s covenants.