HealthEquity, Inc. — Q3 FY2023 Form 10-Q
Business and period: HealthEquity administers health savings accounts (HSAs) and complementary consumer-directed benefits (CDBs). This unaudited quarterly report covers the three and nine months ended October 31, 2022; comparisons are with the same periods in 2021. Amounts below are in U.S. dollars.
Key financial results
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $216.1 million | $180.0 million | $627.9 million | $553.3 million |
| Gross profit | $126.9 million | $103.3 million | $355.8 million | $318.4 million |
| Gross margin | 58.7% | 57.4% | 56.7% | 57.6% |
| Operating income (loss) | $5.5 million | $(0.4) million | $(4.2) million | $3.0 million |
| Net loss | $(1.6) million | $(5.0) million | $(25.9) million | $(11.5) million |
| Adjusted EBITDA (non-GAAP) | $73.4 million | $61.1 million | $198.7 million | $185.6 million |
- Revenue mix: Q3 service revenue was $108.6 million (+6% year over year), custodial revenue $74.6 million (+52%), and interchange revenue $32.9 million (+16%). For the nine months, revenue rose 13%; custodial growth led, while service revenue was nearly flat.
- Cash flow and liquidity: For the first nine months, operating cash flow was $95.2 million, investing cash outflow $108.9 million, and financing cash outflow $1.5 million. Cash and cash equivalents were $210.2 million at October 31, versus $225.4 million at January 31. Management said existing cash, operating cash flow and the revolver should meet operating and capital needs for at least 12 months.
- Debt: Debt principal was $943.4 million ($600 million of 4.50% senior notes due 2029 and a $343.4 million term loan); reported net debt carrying value was $926.7 million. No borrowings were outstanding on the $1.0 billion revolving facility. The term loan’s stated rate was 5.56% and effective rate 6.38%; the company reported compliance with credit covenants.
- Business scale: At quarter-end, HealthEquity administered 7.65 million HSAs and 6.85 million CDBs, or 14.50 million total accounts. HSA assets were $20.2 billion, including $13.1 billion in cash and $7.1 billion in investments.
Material changes and management commentary
- Q3 revenue growth reflected higher custodial revenue, driven by a 27% increase in average daily HSA cash and an increase in average annualized yield to 2.00% from 1.72%. The company expects yields to rise as partner agreements renew or are replaced, assuming the prevailing interest-rate environment continues; fixed-rate contracts delay the effect of rate changes.
- Further, acquired in November 2021, and the March 2022 HealthSavings HSA portfolio acquisition contributed to account growth and costs. Management expects approximately $55 million of Further-related integration expenses over roughly three years from acquisition.
- Q3 net loss narrowed year over year, primarily reflecting higher gross profit and lower merger integration expense. Nine-month net loss widened, as increased technology and development, acquired-intangible amortization, general and administrative, sales and marketing, and interest expenses outweighed gross-profit growth and lower integration costs.
- Management expects continued investment in technology and security and expects sales and marketing, technology and development, general and administrative, and interest expenses to increase in the foreseeable future. It also expects current-year capital expenditures to continue at the then-current level for the remainder of FY2023. No specific revenue or earnings guidance range is provided in the filing text.
Risks, contingencies and unusual items
- Controls: Management concluded disclosure controls and procedures were not effective because of material weaknesses in contract-to-cash controls and IT general controls, including access and change management. Remediation was substantially advanced but continued; management nevertheless stated the interim financial statements fairly present results in all material respects.
- Interest rates and pandemic-related effects: Variable-rate term debt exposes interest expense to further rate increases; a one-percentage-point increase on credit-facility borrowings outstanding at October 31 was estimated to add approximately $3.4 million of interest expense over the next 12 months. Management also cited lingering effects on commuter benefits from remote/hybrid work, COBRA election extensions, and HSA cash yields that remain below pre-pandemic levels.
- Legal matter: WageWorks disputes a landlord’s claim under a terminated Mesa, Arizona lease. The landlord drew a $2.8 million letter of credit and counterclaimed; litigation was in discovery. The company said other described litigation losses were not considered probable or estimable, but an unfavorable outcome could have a material effect.
- Tax: The nine-month income tax benefit was $12.2 million; discrete tax items affected the effective rate. The company was under IRS and Texas examinations and reported $8.8 million of gross unrecognized tax benefits.
- Other exposures: HSA-related tax and regulatory changes, competition, acquisition integration, inflation, data security, and the concentration of $210.2 million of cash in accounts largely exceeding federal insurance limits are relevant risks.
Important facts for investors to verify
- Whether custodial yield gains persist as partner contracts renew, and how quickly higher rates translate into revenue and margin.
- Whether account growth and acquisition integration generate sustainable earnings, given rising operating costs and acquired-intangible amortization.
- Progress in remediating the contract-to-cash and IT control material weaknesses, including any subsequent changes in control effectiveness.
- Debt service and covenant headroom under higher variable rates, and the company’s use of cash for acquisitions and capital expenditures.
- Developments in the Mesa lease litigation, tax examinations, and regulatory or market changes affecting HSAs, commuter benefits and COBRA.