HealthEquity, Inc. — Form 10-Q Summary
Business context and period: HealthEquity provides technology-enabled administration and custodial services for HSAs and other healthcare accounts. This unaudited report covers the three and six months ended July 31, 2016; comparisons are with the same 2015 periods. The quarter is the company’s fiscal second quarter.
Financial performance
| Metric | Three months ended July 31 | Six months ended July 31 |
|---|---|---|
| Revenue | $44.2 million, up 45% from $30.5 million | $88.2 million, up 46% from $60.3 million |
| Gross profit / margin | $28.6 million / 65%; prior year 61% | $56.2 million / 64%; prior year 60% |
| Operating income / margin | $12.7 million / 29%; prior year $7.5 million / 25% | $26.0 million / 29%; prior year $15.5 million / 26% |
| Net income | $8.2 million; prior year $4.4 million | $16.3 million; prior year $9.4 million |
| Diluted EPS | $0.14; prior year $0.08 | $0.27; prior year $0.16 |
| Adjusted EBITDA (non-GAAP) | $18.4 million, up 66%; 42% of revenue | $36.4 million, up 66%; 41% of revenue |
Revenue grew across all three streams. Quarterly service revenue was $18.8 million (+28%), custodial revenue $14.8 million (+64%), and interchange revenue $10.6 million (+56%). For the six-month period, the respective increases were 29%, 64%, and 60%.
Cash flow and liquidity: Six-month operating cash flow was $15.5 million, versus $7.3 million in 2015. Investing used $5.4 million, compared with $44.4 million, largely reflecting the prior-year purchase of marketable securities. Financing provided $15.4 million, primarily from $14.2 million of tax benefits related to stock-option exercises and $1.1 million of option proceeds. Cash and cash equivalents were $109.2 million at July 31; cash, equivalents, and marketable securities totaled $149.5 million, versus $123.8 million at January 31.
Debt and balance sheet: No borrowings were outstanding under the $100 million secured revolving facility, which expires September 30, 2020. The company reported compliance with its covenants. Total liabilities were $11.1 million and stockholders’ equity was $239.5 million at July 31. HSA assets under management are custodial assets, not company cash: total AUM was $4.20 billion, including $3.66 billion of cash AUM.
Material changes and operating trends
- HSA Members increased 50% year over year to 2.30 million. Management attributed growth to new and existing network partners and the prior-year acquisitions of HSA portfolios from The Bancorp Bank and M&T Bank.
- Total AUM increased 60% year over year. Average daily cash AUM rose 63% in the quarter; the average yield was 1.58%, versus 1.56% a year earlier. For the six months, yield was unchanged at 1.56%.
- Service revenue per HSA Member declined about 15% for the quarter and 14% for the six months, reflecting lower tiered fees as partner membership grows. Management said higher custodial and interchange revenue per member partly offset this decline.
- Gross margin improved as service costs per member fell with increased scale and efficiency. Operating expenses nevertheless increased 43% for the quarter and 44% for the six months, including higher staffing, sales and marketing, technology investment, and acquired-intangible amortization.
Outlook, risks, and notable items
- No specific earnings or revenue guidance is provided. Management expects annual gross margin to remain relatively steady near term, while sales and marketing, technology and development, and general and administrative expenses are expected to increase in dollars. Capital expenditures are expected to rise during the remainder of fiscal 2017 to improve the proprietary platform and support new office space.
- Management believes existing cash, equivalents, and marketable securities will fund operating and capital needs for at least 12 months. Additional financing could be needed if anticipated liquidity proves insufficient, and financing may not be available on favorable terms.
- Key exposures include prevailing interest rates, changes to laws and tax treatment affecting HSAs, healthcare-sector changes, competition, regulatory requirements, and the company’s ability to scale technology and partner operations. Management notes that a sustained fall in market rates could reduce custodial revenue.
- Acquisition-related expenses were $0.6 million for the six months. The effective tax rate declined to 35.6% from 36.6%, primarily due to research and development tax credits. A $14.3 million tax benefit from stock-option exercises was recorded in financing cash flow; $7.4 million related to excess option benefits previously limited.
- Operating commitments were reported as not materially changed. The company reported no litigation expected to have a material adverse effect, no material changes to its stated risk factors, and effective disclosure controls.
Important facts for investors to verify
- Whether membership and AUM growth continue to translate into revenue and cash generation, particularly as service revenue per member declines.
- How custodial yields, partner deposit terms, and member interest costs affect custodial revenue and margins if interest rates change.
- Whether planned platform and office investments deliver capacity and efficiency without materially pressuring expenses or cash flow.
- The recurring versus nonrecurring contribution of stock-option tax benefits, acquisition costs, and non-GAAP adjustments to reported results.
- The terms, covenant headroom, and practical availability of the undrawn $100 million credit facility; verify also that future liquidity remains sufficient as capital spending increases.