HealthEquity, Inc. — Q2 FY2019 Form 10-Q
Reporting period: Quarter and six months ended July 31, 2018. HealthEquity provides technology-enabled administration and custodial services for health savings and related accounts. Unless noted, amounts are in U.S. dollars.
Financial and operating performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $71.1 million (+25%) | $56.9 million | $141.0 million (+26%) | $112.3 million |
| Gross profit | $46.6 million | $35.8 million | $90.9 million | $69.5 million |
| Gross margin | 65.5% | 63.0% | 64.5% | 61.9% |
| Operating income | $21.6 million | $16.5 million | $42.1 million | $32.4 million |
| Net income | $22.5 million | $16.9 million | $45.1 million | $31.0 million |
| Diluted EPS | $0.36 | $0.27 | $0.72 | $0.50 |
| Adjusted EBITDA, non-GAAP | $31.8 million (+33%) | $23.9 million | $61.4 million (+32%) | $46.4 million |
- Revenue mix, Q2: Service revenue was $24.9 million (+9%), custodial revenue $30.7 million (+44%), and interchange revenue $15.4 million (+21%). Custodial revenue benefited from higher average custodial cash balances and yield: yield rose to 2.11% from 1.83%, while average daily custodial cash increased 23% to $5.5 billion.
- Scale: HSA Members reached 3.574 million, up 23% year over year; active members totaled 2.933 million, up 19%. Custodial assets were $7.031 billion, up 31%, including $5.537 billion in custodial cash and $1.494 billion in investments.
- Cash flow: Six-month operating cash flow was $52.6 million, versus $39.8 million. Investing used $8.8 million, versus $17.1 million; financing provided $18.5 million, primarily from stock-option exercises, versus $7.1 million. Cash and cash equivalents rose to $261.8 million from $199.5 million at fiscal year-end.
- Liquidity and debt: Cash, cash equivalents and marketable securities totaled $302.9 million at July 31, compared with $240.3 million at January 31. The company had no borrowings under its $100 million secured revolving credit facility and reported compliance with its covenants. Current assets were $339.7 million and current liabilities $17.1 million.
Material changes and accounting items
- Revenue growth substantially outpaced service revenue growth, with custodial revenue the largest contributor. Service revenue per HSA Member fell approximately 12% in the quarter, partly reflecting tiered partner pricing; custodial revenue per member rose approximately 17%.
- Operating expenses rose 30% in Q2 and 32% for the six-month period, including higher sales and marketing, technology and development, general and administrative, and acquired-intangible amortization costs.
- Effective February 1, 2018, HealthEquity adopted ASC 606 using the modified retrospective method. It now capitalizes eligible sales commissions and amortizes them over estimated customer relationships. Adoption did not materially affect revenue; it increased six-month net income by $248,000 versus the prior accounting method and raised July 31 accumulated earnings by $13.5 million relative to the without-adoption presentation.
- The company recorded income tax benefits of $1.0 million for Q2 and $3.1 million for the first six months. Management attributed the lower tax burden principally to the federal corporate tax-rate reduction and research and development credits, with stock-based compensation tax benefits also affecting the effective rate.
Outlook, commentary and risks
- Management expects capital expenditures to increase during the remainder of fiscal 2019 to support proprietary-system improvements, office improvements, and growth. It believes existing cash, securities and operating cash flow will meet operating and capital needs for at least 12 months.
- Management expects continued investment in sales and marketing, technology and development, and general and administrative functions. It expects technology and development expense to increase as a share of revenue over the near term; it expects gross margin to increase somewhat as custodial revenue grows as a share of total revenue, though margins may fluctuate.
- Key sensitivities include prevailing interest rates and custodial-deposit contract terms; changes to U.S. healthcare policy or tax treatment of HSAs; competition and partner retention; and the company’s ability to scale service and technology operations. Cash and securities of $302.9 million were largely above federally insured limits; the filing reports only $750,000 was federally insured.
- The company reported no material change in previously disclosed risk factors, no litigation expected to have a material adverse effect, and no material change in contractual obligations. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether custodial revenue growth and the 2.11% custodial cash yield are sustainable as rates, partner contracts and member interest arrangements change.
- How much revenue and custodial-asset growth came from organic member additions versus acquired portfolios, and whether acquisition costs and amortization affect future returns.
- Whether operating expense growth, particularly technology and development and sales and marketing, remains consistent with revenue growth and margin expansion.
- The ongoing earnings and cash-flow effects of capitalized sales commissions under ASC 606, including the assumptions for 15-year HSA and 10-year 401(k) relationship lives.
- Exposure to uninsured cash balances, interest-rate changes, healthcare regulation, and credit-facility covenants; confirm the facility remains undrawn and covenant-compliant.