HealthEquity, Inc. (NASDAQ:HQY) Q1 2024 Earnings Call Transcript

HealthEquity, Inc. (NASDAQ:HQY) Q1 2024 Earnings Call Transcript June 5, 2023

HealthEquity, Inc. beats earnings expectations. Reported EPS is $0.5, expectations were $0.41.

Operator: Good day and welcome. I would now like to turn the conference over to Richard Putnam to HealthEquity’s Earnings Call. Please go ahead.

Richard Putnam: Thank you, Sara. Hello, everyone. Welcome to HealthEquity’s first quarter of fiscal year 2024 earnings conference call. My name is Richard Putnam, Investor Relations for HealthEquity and joining me today on the call is Jon Kessler, President and CEO, Dr. Steve Neeleman, our Vice Chair and Founder of the company, and Tyson Murdock, the company’s Executive Vice President and CFO. Before I turn the call over to Jon, I have two important reminders. First, a press release announcing our financial results for the first quarter of fiscal 2024 was issued after the market close this afternoon. The financial results included contributions from our wholly owned subsidiaries and accounts they administer. The press release also includes definitions of certain non-GAAP financial measures that we will reference today.

A copy of today’s press release, including reconciliations of these non-GAAP measures with comparable GAAP measures and a recording of this webcast can be found on our Investor Relations website, which is ir.healthequity.com. Second, our comments and responses to your questions today reflect management’s view as of today, June 5, 2023, and will contain forward-looking statements as defined by the SEC, including predictions, expectations, estimates or other information that might be considered forward-looking. There are many important factors relating to our business, which could affect the forward-looking statements made today. These forward-looking statements are subject to risk and uncertainties that may cause our actual results to differ materially from statements made here today.

We caution against placing undue reliance on these forward-looking statements, and we also encourage you to review the discussion of these factors and other risks that may affect our future results or the market price of our stock as detailed inour annual report on Form 10-K and subsequent periodic reports filed with the SEC. We assume no obligation to revise or update these forward-looking statements in light of new information or future events. At the conclusion of our prepared remarks, we will open up the call for Q&A with the help of our operator Sara. One final announcement before we hear from Jon, due to some conflicts recently encountered, we are postponing our Investor Day that was planned for July 11, to be at a later to be announced date.

Once we have rescheduled the date, we will provide you with the press release and invitation. Now, over to you, Jon.

Jon Kessler: Hi, everyone, and thank you for joining us for a healthy start to fiscal 2024. I will discuss Q1 key metrics and our view on performance, and Tyson will detail Q1 results, as well as our raised guidance for the fiscal year, and Steve is here for Q&A. In Q1, the team delivered double-digit year-over-year growth in revenue, which was plus 19%, adjusted EBITDA, which was plus 48%, and HSA assets which were plus 10%. HSA members grew 9%, total accounts grew 4% muted by the previously discussed change in COBRA methodology. HealthEquity ended Q1 with 15 million total accounts, 8 million HSAs and 22 billion in HSA assets, all kind of round numbers, and 10% more of our HSA members became investors year-over year, invested assets grew 12%, despite a dicey market.

Team Purple started the selling year off strong with 134,000 new HSAs opened during the quarter, that’s down 25,000 year-over-year and we expected a drop given the comp to last Q1’s blistering job growth and turnover rates economy wide, but we’re particularly pleased actually that, that was nearly offset by new employer adds, including across the board for HSAs. In addition, at this time last year, we saw transfers of HSAs from banks that were exiting the business. Obviously, this year, and given the competition for cash, we did not see that same activity. Enterprise logo wins that will onboard later in the year were up noticeably year-over-year, driven by an expanded net partner footprint and employers seeking win-wins in anticipation of a tough calendar ‘24 benefits renewal.

For the full-year, we are increasingly confident that increased HSA adoption at the employer level will help to offset lower macro job growth. Q1 saw some daylight on CDV growth, our CDV members grew accounts in the quarter by excluding COBRA as a whole by 4% and by 1%, if you simply exclude the aforementioned adjustment of COBRA accounting methodology. Health CDVs, FSAs and HRAs were strong, as the onboarding of significant new logos offset some seasonal runoffs, commuter maintained its slow rebound, extra ACA exchange subsidies continue to negatively impact COBRA uptake and therefore activity fees and to compensate for that, the team has begun raising fixed fees with good early success, which is very much needed. While there’s much wood to chop on service fees, service costs actually fell by 40 basis points year-over-year, even as revenue increased despite wage gains for our team members as we benefited from a much calmer service environment versus a year ago quarter.

As we discussed last quarter, rapid improvement in service tech continues to drive more interactions to chat and automated responses and we believe there is more to come of this over the longer term. Q1 also provided a preview of what we believe is to come over the longer term with respect to custodial fields — fees as — fields — fees is like fields plus yields that will be fields, good luck with that transcriber. As yields on our ladder bank deposit portfolio rose out of the COVID debts and more members chose enhanced rates for or chose enhanced rates for their HSA cash. You saw the strength of our model over the course of the quarter as we talked about in March. High short-term rates provided a boost to income on CDB client health loans as well.

All of this adds — added up to strong and resilient cash flow from operations, which as Tyson will detail, led to a return to GAAP profitability in Q1, allowed management to reduce outstanding — which allowed management to reduce outstanding balance on HealthEquity’s variable rate term loan A debt and enables us to continue to invest in future growth and innovation. Mr. Murdock will now detail the financial results and outlook.

Tyson Murdock: Thank you, Jon. I will highlight our first quarter GAAP and non-GAAP financial results and a reconciliation of GAAP measures to non-GAAP measures is found in today’s press release. First quarter revenue increased 19% year-over-year. Service revenue was $105.1 million, up 1% year-over-year and custodial revenue grew 59% to $94.4 million in the first quarter. The annualized interest rate yield on HSA cash was 232 basis points. Interchange revenue grew 7% to $44.9 million. Gross margin was 60% in the first quarter this year versus 54% in the year ago period. Net income for the first quarter was $4.1 million or $0.05 per share on a GAAP EPS basis. Our non-GAAP net income was $42.8 million for the first quarter and non-GAAP net income per share was $0.50 per share, compared to $0.27 per share last year.

While higher interest rates increased custodial yields and generated interest income, they also increased the rate of interest we pay on the remaining $287 million term loan A to a stated rate of 6.6%. Adjusted EBITDA for the quarter was $86.6 million and adjusted EBITDA margin was 35%, a more than 700 basis point improvement over last year. Turning to the balance sheet, as of April 30, 2023, we used $54 of cash to reduce our outstanding variable debt resulting in a quarter end balance of $226 million of cash and cash equivalents with $873 million of debt outstanding net of issuance costs. We continue to have an undrawn $1 billion line of credit available. For fiscal ‘24, we’re raising guidance and now expect the following, revenue in a range between $975 million and $985 million.

GAAP net income to be in the range of $9 million to $14 million. We expect non-GAAP net income to be between $164 million and $171 million, resulting in non-GAAP diluted net income between $1.88 and $1.97 per share based upon an estimated 87 million shares outstanding for the year. We expect adjusted EBITDA to be between $333 million and $343 million. As Jon mentioned, we are basing fiscal ‘24 interest rate assumptions, embedded in guidance on forward-looking market indicators, such as the secured overnight financing rate and mid-duration treasury forward curves and fed funds futures. We are raising the expected average yield on HSA cash to approximately 235 basis points for fiscal ‘24, while the average credit rating or HAS members receive on — the average credit rating HSA — rates on HSA members receive on HSA cash remained flat sequentially.

We continue to bake in a 20 basis point increase by the end of fiscal ‘24. As a reminder, the crediting rate, our HSA members receive are determined in accordance with the formula in our facility agreements with them. Our guidance also reflects the expectation of higher average interest rates on HealthEquity’s variable rate debt versus last year, partially offset by the reduced amount of variable rate debt outstanding. Our guidance includes a smoother, seasonal cadence of revenue and earnings, which were disrupted last year by heavier first-half service costs, as we exited the pandemic and also the rapidly rising rate environment that benefited last year’s second-half disproportionately. We expect that interchange revenue seasonally would be more normalized this year and as suggested earlier, a relatively stable interest rate environment over the remainder of this year.

We assume a projected statutory income tax rate of approximately 25% and a diluted share count of 87 million, which now includes common share equivalents as we anticipate positive GAAP net income this year. Moving to positive GAAP net income is going to impact our GAAP tax strangely this year. As you know, because of the impact of discrete tax items, the calculated tax rate on a low level of pretax income can look squarely, such as Q1’s calculated 59% tax rate. Based on our current full-year guidance, we expect roughly a 50% GAAP tax rate for fiscal ‘24. As we’ve done in recent reporting periods, our full fiscal 2024 guidance includes a reconciliation of GAAP to the non-GAAP metrics provided in the earnings release and a definition of all such items is included at the end of the earnings release.

In addition, while the amortization of acquired intangible assets is being excluded from non-GAAP net income, the revenue generated from those acquired intangible assets is not excluded. And with that, we now have a — we know you’ll have a number of questions, so let’s go right to our operator for Q&A instructions. Thank you.

Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Glen Santangelo with Jefferies. Please go ahead.

Glen Santangelo: Yes, thanks and good evening and thanks for taking the question. Hey, Tyson, I just had a couple of quick financial questions, if I could, just to sort of help us sort of model this thing more correctly. It says now that you have total HSA assets of $14. 1 billion could you give us a sense for how much of that fits in variable and maybe how much of it you’re investing in? Is it still a third, a third, a third, is that the right way to think about it? And the reason I ask is because we’re trying to assess not only this year, but next year and I know you don’t want to comment on fiscal ’25, but at the current yield curve, it sort of looks like the yield would be even much more year-over-year in ’25 versus ‘24. Nice one, you don’t know if I’m thinking about that math correctly and I’ll stop there. Thanks.

Tyson Murdock: Yes, good question. So the variable interest rate portion, of course, is getting smaller with the enhanced rate push. We don’t need as much of that, so there’s not as much impacting. Another thing to consider is the fact that, obviously, the rates last year accelerated so substantially over the course of the year that the second-half was impacted by that — on that variable component. So people got very concerned about, well, how much of that variable component. But based on the size of that amount, it’s not very big. And it’s going to be obviously more consistent even though you may see a curve that sort of curves down. So that’s kind of one area. The next is a question that we get, when you think about how the assets run through the model.

Again, they get more consistent as we move into enhanced rates and that has its own liquidity factors. But you think you’re thinking about the FDIC portion, which of course is lumpy because of the M&A that occurred over all those years. So think back about the WageWorks Acquisition, the Further Acquisition and those type of things. And the fact that as we go through integration processes on those, we place those assets into five-year contracts. And so they have to sit in those five-year contracts for five years. And then that causes as when you look back over time, you probably get a smaller amount that rolls off in this next year than you might think when you think about maybe what you mentioned, which is the one-third, one-third, one-third, based on sort of the three-year duration you might get off of those five-year placements.

So what I’m telling you is that the number is smaller than that one-third. You have to go back quite back in time, even prior to the acquisition, to determine sort of what that — prior to those big acquisitions to look at what that looks like. And so it will be a smaller number. So Jon, I don’t know if you want to make any additional comments to that.

Jon Kessler: We I was keep going. We’ll see what we here. Thanks, Glen.

Glen Santangelo: Thank you, very much.

Jon Kessler: I will say that was just for other analyst benefit. That was a one-part question. That wasn’t a four-part because we’re not starting with the four-parters. First off, Glen, I was going to pull — I don’t know, some other analysts do does four, five part questions. Sorry, I’m sorry, Sarah. I didn’t mean to interrupt.

Operator: Alright. No problem. Our next question comes from Stan Berenshteyn with Wells Fargo. Please go ahead.

Stan Berenshteyn: Hi, thanks for taking my questions. First, I just want to make sure I called this correctly. You said you’re increasing service fees that your employers are paying, and it seems like you’re early in that. Can you just give us thoughts on the methodology? And how long do you expect until everybody is on board with the new pricing?

Jon Kessler: Well, in particular, that comment refers and now Tyson is chuckling at me because we had a small bet about whether anyone would ask about this, which I just lost — so thank you for asking. But what I was really commenting on there was, in particular, this is several quarters where COBRA has been a bit of a drag for us. And although I will say overall, we were glad to see a black number on CDB and an almost crookedy looking black number on CDB ex COBRA. So that was pretty good. But my comment was focused on COBRA. And there, the real issue is that we now have in place for several more years now, incremental subsidies, sort of, sometimes humorously referred to as it’s the extra Affordable Care Act. I think that’s by the proponents of these things.

And they were originally put in place from the pandemic, but they’ve been extended for a couple of years. And the result of that is lower COBRA uptick. So that doesn’t necessarily change the offer rates, but it does affect what we call activity fees in COBRA. And so naturally, the way we should be making up for that is increasing the service fee component. And like all of our products, COBRA is sold both directly and through our channel partners, in particular, in this case, our health care partners. So we want to work with them carefully, but we have begun to roll out modest fee increases for the service fee component to, kind of, make up that difference. And I think people understood that, that was kind of coming, because the service — the cost of delivering service hasn’t fundamentally changed.

So it’s really focused on COBRA. And again, the idea isn’t that this is going to drive some major magic, but we do want the overall CDB growth number from a revenue and so forth perspective to ultimately be a black number. It’s not going to be the driver of our growth, but we don’t want it to be dragging us again.

Stan Berenshteyn: Got it. And then maybe just a quick follow-up, and I don’t know if you have any money on this. But just back to your prepared remarks, I think you commented that you had more focus on chat-based communications. Can you maybe just give us an update on the adoption of text-based communications within your member base? And then maybe related to that, are you seeing any opportunities to enhance member communication with maybe like generative AI technology that’s coming up? Thanks.

Jon Kessler: So I don’t think there was money on either of these. By was there is a — there are a number of wagers around whether the term — those two initials that you just mentioned would appear out of my mouth. And I’m going to see if I can — like it’s more whether I can get through without it more than anything else. Let’s find out. But let’s say this in all seriousness, I do think that it’s fair to say that for us and others, the advances in these areas have really accelerated our ability to automate communications on a lot of the more basic queries that we get and deliver ultimately what from the member’s perspective is rated to be a superior experience. So we have seen — if you were to look at a chart of text-based and then automated text-based over the course of the last, really, six or eight months, it has gone up quite a bit.

Both have gone up. I believe and I may be off here, but in rough turns right now, one out of every six or seven of our transactions is text-based. And of those transactions with our members’ interactions, of those between one out of three, and almost one out of two are automated. And so yes, the new stuff is helping, and I think it’s going to help. I mean the nature of my commentary is, again, if you look at service cost, service costs fell year-over-year. Now there are some other things going on as I acknowledged in the script. Last year’s comp was — let’s say last year first quarter service cost was not good. So that certainly helped. But even if you factor that out, we did very well. And so I think there’s a lot more to come here in terms of our ability to both simultaneously improve member experience and reduce costs on the service line.

Stan Berenshteyn: Awesome. Thanks so much.

Richard Putnam: Thanks, Stan.

Operator: Our next question comes from Anne Samuel with JPMorgan. Please go ahead.

Anne Samuel: Hey, thanks so much for taking my question and congrats on the great results. Jon, you spoke earlier in your prepared remarks about your strength in new employee adds for HSAs kind of coming in a little bit better than you had expected. I was just wondering if you could talk a little bit more about that. What are you seeing? Is it labor growth, better enrollment. What’s driving that?

Jon Kessler: So interesting, in our expectation, as I suggested in the prepared remarks, was, and we’ve tried to communicate this for quite a while, was that when — was that we really were benefiting from both growth in the labor market and turnover in the labor market. And in fact, if you look at last year, sort of the variance year-over-year with the exception of Q4, kind of maybe including Q4, kind of came down as turnover in the economy kind of came down and job growth kind of relative to Q1 of last year kind of came down. So now turning to this first quarter, I mean the way I look at it is that, basically, the growth of new logos, meaning at this point in the year, mostly smaller employers that would be starting in February, March, April, a few holdovers from January that were late, that kind of thing.

But those numbers almost offset the reduction in what I would call kind of purely organic, same employer growth relative to last year. And so that’s pretty good when you think about the fact that in the economy as a whole, we’re producing jobs at about 55%. It’s still extraordinary, but we’re producing jobs at about 55% of the rate that we did last Q1, this Q1. And I don’t know what’s shaking or if you all can hear that shaking. But hopefully, it’s nothing. Oh, I do know it’s shaking. It’s a big drill. We got an interesting scene outside. But — and also, when you consider that turnover, particularly voluntary turnover, has declined in the economy as a whole pretty significantly, and so we feel pretty good about that. We did have fewer transfers of HSAs from smaller banks, as you might imagine, folks trying to hang on to those accounts in a period where banks have been trying to hang on to deposits, and that accounted for the biggest portion of the delta year-over-year.

So I guess my basic view is that if you look at the full year, we have some level of confidence that new logo growth is going to be sufficient to, if not fully offset, at least significantly offset what are — what we expect to be a reduction in the strength of the labor market in the course of the year. And so that was meant to be a statement of confidence and, hopefully, will be interpreted that way.

Anne Samuel: That’s great to hear. Thank you.

Richard Putnam: Thanks, Anne.

Operator: Our next question comes from George Hill with Deutsche Bank. Please go ahead.

George Hill: Hey, good evening, guys. And thanks for taking the question. Jon, this might be kind of a dovetailed question on Anne’s question that was just asked. But I thought I heard you say in your prepared commentary that you’re seeing increased HSA adoption at the employer level that will kind of offset job growth. So I guess my question is like, are you guys seeing an underlying change in the adoption of HSA levels that is kind of different from the historical trend of them growing 3%-ish a year? And would be interested to hear you talk about what’s driving that like in the underlying adoption rate.

Jon Kessler: It’s early in the year, obviously. And — but when you look at our, I guess, conceptually, you can think of it as our pipeline, meaning our wins that will onboard later in the year, they have — they are also well ahead of last year. And I do think that what’s going on underneath that, actually, let me ask — since we have Steve on the line, Steve, you’re out there. I don’t know if there are any employer prospects in your current undisclosed location, but maybe. Can you talk a little bit about what’s driving that activity at the employer level and with our partners?

Steve Neeleman: Absolutely. And I would have been with you in New York, but I wasn’t invited. But anyway, George, didn’t hear your voice. Look, I just think that — we talked about this in the past. I remember when we had — we did have a nice large name brand employee that came on in the first quarter with an HRA, which has helped on the CDB stuff. And then more broadly, as we look at employers and what they’re looking at towards the end of the year, I think most of the employers are thinking, you know what, costs are up, inflation is up. I think a lot of them are — especially in the midsized are anxiously awaiting to see what’s going to happen on the health care claims. Since most people on this call that know health care, they realize that hospitals are seeing higher labor costs.

And at some point, you’re going to have to translate this through to higher cost to payers, which ultimately ends up getting paid for by employers and things like that. And so — and then if you just kind of wrap in the employer’s own wage inflation issues and more broad inflation issues. I think most employers are saying, look, we know HAS. They read our case studies, and they see big brand name companies that are doing HSAs in kind of novel, interesting ways. We’ve got a case study out there where an employer figured out that you could fund lower income people’s accounts more when you find higher income people’s accounts, which drives higher adoption in lower areas where we used to see lower adoption on some people that are now starting to have accounts more.

So that all combined with our kind of our Engage360 MAX enroll initiatives, where we’re getting more and more employers signing up to allowing us to be able to reach out to their people in advance even of enrollment and take out these things, I think, are resulting in the fact that we’re just executing better. And you never want a recession to be a factor of the drug of our business because we know it hurts all businesses, and we know it does offset with just as Jon pointed out, lower overall job growth. But we do think that HSA is because of the cost savings they can bring to employers because of the tax savings and tax savings revolves and employers that it is one of these things that tends to start to get more interest when you’re in a tougher economic environment.

So that’s what we’re seeing, George. And we’re doing a better job, honestly, than we’ve ever done before, thanks to our marketing and our inside sales teams. And we look out and just getting the word out. I think it’s a combination of things. But as far as the new logos are concerned, and Jon spoken to that, but we’re kind of fingers crossed. We’ve had some really good sales here, and we’re looking forward to bringing on some of these great new clients this year.

George Hill: That’s super helpful. And if I could have what I hope is a very quick follow-up. Just a lot of us on the health care side are tracking the growth of the GLP-1 drugs that tend to come out of the gate pretty expensive and tend to blow through people’s deductibles pretty quick. I was just wondering if you guys are seeing any impact at all on HSA balances or an increase in volatility, the balances through the GLP-1 drugs?

Jon Kessler: No, not yet.

George Hill: Okay. Easy answer. Thank you.

Richard Putnam: Thanks, George.

Jon Kessler: Thanks, George.

Operator: Our next question comes from Greg Peters with Raymond James. Please go ahead.

Greg Peters: Well, good afternoon, everyone.

Jon Kessler: Hey, Greg.

Greg Peters: Steve, I’ll invite you to New York if Jon won’t just in case that matters.

Steve Neeleman: Very kind of you. Thank you.

Greg Peters: Yes. I guess can you comment on the seasonality in general administration and merger integration-related expenses? The reason why I’m asking is they came in a little bit below where I was certainly thinking, and I noticed you didn’t change in merger integration guidance for the full-year. I would have thought that would have tapered off through the year, but it seems like you’re sticking with that number. So just some detail on that would be helpful.

Tyson Murdock: Yes. I mean we’re sticking with the number. We got to spend it, and I think if the timing of it is just it’s getting so small now that the timing may add some volatility to it, Greg, is what I would say. So and then you mentioned G&A as well.

Greg Peters: Yes.

Tyson Murdock: I want to make sure I understand that question a little bit more. Maybe just…

Greg Peters: I’m just — I’m sorry, just inside the P&L, there’s a line item, general and administration expense. And I’m just — it came in a little bit lighter than I was just wondering if there’s anything going on inside there or if that’s, sort of, the normalized expectation that was evident in the first quarter.

Tyson Murdock: Yes, I may go a little bit further just because you brought that line. I just — last year, we had some stock comp forfeiture right in there. So if you look at last year versus this year, you’ll see that it goes up actually. But from a trend line perspective over a long period of time, of course, we’re trying to get some of the synergies running through there and things like that from that, so I think you see some of that as well. But it’s a pretty small volatility in my mind if you just look at the longer-term quarters going back through time. So I hope that answered what you’re trying to ask.

Greg Peters: I think so. I can take the rest off-line. My other question was just on debt paydown that’s running ahead. What’s your expectation for the year on that?

Tyson Murdock: Just we’ll take it as we go. I mean we’ll look at what it is. What we did there is we paid off the principal payments for quite some time. So you won’t see any short-term portion of that anymore. And so cash accumulation is going to help that. And I’m talking about the next couple of years, we won’t have principal payments on it. We were able to elect it that way. So we thought that was a positive thing to do for the business and just make a bite at it.

Greg Peters: Okay. Makes sense. Thanks.

Richard Putnam: Thanks, Greg.

Operator: Our next question comes from Sandy Draper with Guggenheim. Please go ahead.

Sandy Draper: Thanks very much and congrats on the strong quarter. This is one question about seasonality, but it applies to two lines. So first off, just trying to make sure, sort of, asked a little bit earlier, Tyson, when I’m thinking about either sequentially or year-over-year, the change in account or revenue per account, I’m trying to get the dynamics of the strong growth in HSAs lower price. You’re starting to see some uptick in the CDBs, at least sequentially. But you’re still down, by my math, about $0.07. So should we be thinking about sort of flattish? Or is it the season should be thinking about a year-over-year change? And how do we think about seasonality there? And then I wasn’t quite clear what you referenced when you commented about normal seasonality on the interchange with how you’re usually thinking about it.

The first quarter is the highest drops down for the next two and then steps back up in the fourth quarter, but maybe not for the first quarter. Is that what you’re applying? So I just want to make sure I’ve got the seasonality of those two target.

Tyson Murdock: Sure. Yes, I mean the second part, I think I’ll take that, but you already kind of gave the answer. We just want to reiterate that that’s how that seasonality works. And so you may see from a perspective of a little bit of better growth rate, maybe this quarter, okay, that’s fine, but it’s really just that same seasonality. And what we really are trying to make sure on that seasonality comment in the script is just that if you look back over time, we had pandemic, we had — last year, we had an acquisition even a couple of years ago, right, that plays in that I just feel like people — I want to make sure people understand that the quarters are a little bit more sequential and that we don’t want people to get out of theirselves.

The other thing to mention there, too, is just the impact from the variable rates that we’re playing into the second half of last year as well. So that’s kind of a longer answer to your question. And so again, just reiterating on top of that, the interchange portion of that is just normalized. And Jon, you’re going to take the first part.

Jon Kessler: Yes. I mean, Sandy, the first part of your question was really about, I think, was about unit service fees and meaning service fees over total accounts. And I think you’ve kind of got all the right pieces. I mean the bulk of service fees, as you know, come from the CDB side of the business. And so as HSAs grow total accounts, there’s a little bit of downward pressure there just from a mix shift perspective. But we seem to be holding our own there pretty good, and I think that’s a fair way to look at the full-year. I’d probably just leave it there.

Sandy Draper: Got it. That’s helpful. Thanks.

Richard Putnam: Thanks, Sandy.

Operator: Our next question comes from David Larsen with BTIG. Please go ahead.

David Larsen: Hi, congratulations on the good quarter. Can you talk a little bit more about your expectations for yield? I think you said it came in at 232 bps for the quarter. I think it was 211 bps last quarter. The guide, I think you said, is 235. Is that accurate? And then over what period of time will you expect to realize the benefit from the increase in the federal funds rate that has occurred over the past year? Will that take a couple of years? And I guess what I’m getting at is why only, I think, the 3 basis points of incremental yield between now and year-end. Thanks.

Jon Kessler: Yes. So during the year, during any particular fiscal year, the real variability that we see during the year is around the relatively small portion of our HSA cash that’s in variable instruments. And last year, as you know, rates shot up throughout the year as that funds rate did. And that really explains most of the increase that you saw there, plus the fact that we had good growth in cash and so forth. And so this year, it’s — again, we’ll see what really happens. But as you know, our guidance is based on forward curves now. And our guidance, if you kind of look at forward curves, you can see we sort of, in terms of variable rates, kind of peak up and then swing down. Our basic view is that the result of that is a much smoother situation over the course of the year relative to last year and similar to many prior years. And so our guidance is in that way. So what you said at the outset, yes, it is absolutely correct.

David Larsen: Okay. Great. And then can you maybe just talk a little bit about the interchange revenue? I think it was short a very, very good pop sequentially. I mean, what are the key drivers there? I mean is it commuter revenue? Is it health care utilization and general utilization in the hospital and physician office environment? Just any additional color there would be very helpful.

Jon Kessler: Yes. I think the answer is the commuter does help a little bit because it is outgrowing. But really, a way to look at it is that the growth we saw in interchange, kind of, mirrors the growth in, for lack of a better term, accounts with cards and so on a year-over-year basis. So that’s our new HSAs and some of our CUVs. So it’s really — that’s pretty much what it is.

David Larsen: Okay. Great. And if I could just squeeze one more in there. The HSA members, it was really flat sequentially. If we adjust for COBRA, what would that have been? And then when do you expect to fully comp the COBRA impact?

Jon Kessler: Could you ask that one more time? I’m sorry [Multiple Speakers]

David Larsen: The number of HSA members relative to Jan ’23, it was up a little bit sequentially, but looks kind of flat to me actually. Just is that because of the COBRA impact? And when would you expect to fully comp that?

Jon Kessler: Well, I think what you’re referring to is total members. Let’s just say HSA members are up 9%, total accounts on a year-over-year basis. You’re talking sequentially.

Richard Putnam: And to that point, David, our fourth quarter is when HSAs come in, there isn’t a lot of HSAs.

Jon Kessler: Right. You have 1035 open and some closures. So your growth is going to be, what, $100 or 90 or something. And that’s on the base of $8 million. So it’s the first quarter is the answer to that in.

David Larsen: Great. Thanks very much.

Jon Kessler: Thanks, David.

Operator: Our next question comes from Scott Schoenhaus with KeyBanc. Please go ahead.

Scott Schoenhaus: Thanks. Congrats, guys. Thanks for taking my question. Apologies if I missed it, but state where you book the book of businesses in terms of enhanced rate? And did you reiterate your 30% target for the end of the year?

Jon Kessler: I didn’t know that thing you risen to the level of something we reiterate. But yes, it’s still our target.

Scott Schoenhaus: Okay. And where are you currently at, Jon?

Jon Kessler: We’re a few hundred basis points shy of that. We’re going to get there.

Scott Schoenhaus: Great. Great. And just a question on the M&A environment. I know that it has been kind of slower than you expected given that these banks want to hold on to the sticky HSA assets. Has anything changed from three months ago when you made those comments?

Jon Kessler: Fundamentally know, I do think that — I think it’s a point where because — let me back up and say one thing, which is, as other analysts have noted, we have a ladder strategy. And some of our competitors have a more exposed strategy, either by virtue of the way they’re structured or otherwise. And so if you’re more exposed, and I’m not thinking about the small banks, but maybe some of the other competitors, if you’re more exposed to lap to short rates, this might be a time where you’re really looking at this because if you think that things are going to get wild and wooly with short rates. And so there’s a little bit of that kind of chatter. But fundamentally, I mean, look, the fact that we did a pay down and so forth suggest that we feel like this is a period where we’re more accumulating capital than spending it.

And I think that’s probably fair. And again, it also impacts our new HSA openings in the sense of just smaller HSA transfers that occur from smaller banks.

Scott Schoenhaus: Thanks for the color.

Richard Putnam: Thanks, Scott.

Operator: Our next question comes from Stephanie Davis with SVB Bank. Please go ahead.

Stephanie Davis: Hey guys. Congrats on the quarter and thank you for taking my question. So I hate to be the one to bring up bank turmoil. But last quarter, we did have a lot of discussions around enduring impact from some of the events in March and how it can maybe create greater demand for your sticky HSA deposits, and the bank turmoil has continued. So I was wondering if you’ve seen any greater interest in custodial partnerships, from folks like additional banks or if you’re still mostly focused on second-story banks and avoiding the regional bank opportunity?

Jon Kessler: So I’m going to say yes to your first question. And on your second question, what we really concern ourselves with is from our perspective, and it’s not — we concern ourselves with the general quality of the institution. And it’s not that we’re, how do I say, it’s not that we’re — at the end of the day, the FDIC is going to back our members. It’s more that we want to have long-term relationships, and so we don’t kind of want it to be a one and done situation like some SEC colleges and — but not Florida. It’s every graduated. And so…

Stephanie Davis: And my colleges in this question, like Florida.

Jon Kessler: I mean, Florida is awesome. Everyone knows it. Everyone knows it. They got this huge — I could use those two letters that everyone’s talking about these days. Florida is killing anyway. So we’ll move on from there. But the answer to your first question is yes, and the answer to your second question is, we’ll look at those things. We don’t — we’re not — this isn’t a cash deployment season, but we want to build relationships that are going to last with different institutions on where we are.

Stephanie Davis: So let’s do a follow-up on that then. Is there any other way to get more granularity on the yield on side? Just — I mean you had the giant magnitude of the beat. So is it the contract renegotiations came in better than expected, maybe not from regional banks, something else? Was it floating rate mix? Was it enhanced rate mix? Like how enduring is this? And how much could it be an intra-quarter impact?

Jon Kessler: I don’t think it’s a huge inter-quarter impact because of most of the renegotiations and the like that we do are at the end of the year. So this — the benefit we saw in the first quarter was principally a result of the movement to enhance rates and the — and then the benefit on variable cash, so from a yield perspective. So I would think that this could be a benefit to us at year-end. But on the other hand, there’s a lot of stuff floating around at year-end, and year-end a long time away. I will say one of the benefits of the enhanced rates program as it matures over the course of multiple years is that we’re going to have less of this year-end thing. And so you won’t — we won’t all be holding our breath for December and January every year, and that will be good.

Stephanie Davis: I’ll keep quite. All busy. Alright, thanks. I’ll hope back in the queue.

Jon Kessler: That’s not a name we mentioned, because recruiters listen to these things. Say it.

Operator: Our next question comes from Mark Marcon with Baird. Please go ahead.

Mark Marcon: Hey, good afternoon and congratulations. And Steve, we would be thrilled if you were here in New York with us. So we’re super glad here.

Jon Kessler: I didn’t even know I had any authority over where Steve went. That’s a new thing. And I’m sorry, Mark, go ahead.

Mark Marcon: And we’re looking forward to seeing you guys tomorrow. But just a very short question and then a little bit of a longer one. But the super short question is on the enhanced yield product, is the duration structure the same as what you’ve had on your traditional bank partnership agreements?

Jon Kessler: So our cash commitment under enhanced rates is a little bit different. It’s typically a 5-year cash commitment. However, the reason we can do that is that we are — that whereas in the bank products, we have to have separate products to provide for the liquidity. Here, the liquidity is built in. So the actual average duration, if you want to think about it that way, when you account for the fact that there’s a portion that we have, we can pull in and out whenever we want is much closer to our three-year inside track.

Mark Marcon: How sensitive is that portion of the enhanced deal product to changes in yields in the overall market? Is it a…

Jon Kessler: It’s built in — the liquidity component is built into the underlying rate we receive. So again, all of this is designed to produce. In addition to a higher yield overall, it’s designed to produce smoothness over time. We want to get you all as best as we can out of the business, at least for the short and medium term of being fixed income analysis.

Mark Marcon: Okay. Great. And then what — just wanted some general comments with regards to the competitive environment. I mean you’re clearly — you continue to gain the most share and continue to grow rapidly. But just wondering, how has that evolved, say, over the last 2 years? What’s your perspective, Jon?

Jon Kessler: I guess I would generally say that what we’re seeing over this period of time is a continuation of trends that we’ve seen for a long time. If you look at the seven-year information that came out, I think it came out since we last announced. In addition to showing — and maybe it was just before, I can’t remember. But in addition to showing that we had maintained our number one position in terms of both assets and accounts, it does show a consolidation. And that really, if you look at it among the five or five largest players, the growth has principally come from, in market share terms has principally come from HealthEquity and Fidelity. And we do compete with each other, obviously. But we also — and you can see this in the average balances, we also fish in somewhat different ponds in terms of Fidelity, also doing a lot of rollover business and the like as people retire.

And so I think that’s the main — what I’ve seen is that we’re really benefiting at the expense of some other players. I guess I would say one other thing, Mark, that isn’t — it’s not something that’s always very exciting to talk about on these calls. But as we discussed back in March, the team had a very, very good year from the perspective of execution on service to our clients and to their broker partners and our retirement partners and our health partners at the end of the year. And I think that’s helping in terms of new logo wins. I really did. When people have a good experience at the end of the year, like the brokers, they’re more likely to send business your way in the next year. And that’s very much to the credit of Angelique Hill and the service team and our technology team led by Eli Rosner on the tech side and Merv and Larry on the security and IT side.

So I just think that plays a role as well.

Richard Putnam: Thanks, Mark.

Mark Marcon: Terrific. Thank you. Look forward seeing you tomorrow.

Jon Kessler: Yes, sir.

Richard Putnam: Hey, Mark. [Indiscernible]

Mark Marcon: But next time.

Jon Kessler: There’s still red eye, don’t say it. I would call your bluff.

Steve Neeleman: I like you, Mark, when there’s snow on the ground and there’s no snow back there. So…

Jon Kessler: He’s a skier. Who’s next?

Operator: Our next question comes from Allen Lutz with Bank of America. Please go ahead.

Allen Lutz: Thanks for taking the questions. I guess one for Tyson. You talked about the enhanced rate product kind of going from 0 to a goal of 30% this year. So over three years from nothing to 30% of the book. But I’m looking at the custodial cost of goods sold line, and that really hasn’t moved as a percent of custodial cash over that time period. And I’m looking at the enhanced rates here, and they’re obviously higher than the core rate that you’re paying out to the consumer? So I’m just curious, is there something going on with the type of consumer that’s electing for the enhanced rates? Do they have a much smaller cash portfolio than the average, just normal customer? I’m curious what the disconnect is there. Thanks.

Jon Kessler: Yes, I’m going to take this 1 because it’s really — the answer has much more to do with the marketing and so forth. So there are two things going on there. First, keep in mind that the uptake rate among new account holders is very high. And by definition, new account holders have smaller balances. And so we have not — so the impact has been pretty modest in terms of if you sort of fold the whole thing into our custodial expense. Now that will change over time in relative terms relative to what would have occurred with cash. But that’s really the big answer to your question. So — it’s not a function perhaps of like Fed election one way or the other. It is a function of the fact that you are that the product is the people who are most likely to see it are you’re brand new to us, and you’re making a decision upfront about where you’re going to go.

And something like, I want to say, 85% to 90% of our new enrollees are choosing enhanced rates. The second point I would make is that people who keep very large cash balances, the kind that earn relatively high rates, they’re typically doing that precisely, because they place very high value on the FDIC component of it, right? Otherwise, they would be investing those dollars or putting them in a short-term bond fund or what have you. And so in a funny way, it’s not entirely unreasonable to expect that those folks would stay in FDIC cash.

Allen Lutz: Got it. Thank you very much.

Jon Kessler: I thought about this question, too. We were curious about it over the last few quarters. And this is the first time in this form anyone’s asked about it, but that’s the answer.

Richard Putnam: Thanks, Allen.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Jon Kessler for any closing remarks.

Jon Kessler: So first of all, thanks, everyone. I’m sorry if you’ve already pre-purchased Cabana ware, we’ll do our best, like Richard. We did get this thing done in under an hour, which is something to celebrate for you as well as for us, and particularly for Richard. And I think there’s a double standard on the length of answers, mine, where I think, on average, the shortest. But nonetheless thank you all, and I appreciate the team’s work on a great quarter. And we will, if not earlier, see everyone back in September. Bye-bye.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.