HealthEquity, Inc. (NASDAQ:HQY) Q2 2024 Earnings Call Transcript

HealthEquity, Inc. (NASDAQ:HQY) Q2 2024 Earnings Call Transcript September 5, 2023

HealthEquity, Inc. beats earnings expectations. Reported EPS is $0.53, expectations were $0.47.

Operator: Hello, everyone, and welcome to the conference. Please note today’s conference is being recorded. I’d now like to turn the call over to Richard Putnam. Please go ahead.

Richard Putnam: Thank you, Rocco. Hello, everyone. Welcome to HealthEquity’s Second Quarter of Fiscal Year 2024 Earnings Call. My name is Richard Putnam, Investor Relations for HealthEquity. Joining me today on the call is Jon Kessler, President and CEO; Dr. Steve Neeleman, Vice Chair and Founder of the Company; the Company’s CFO, Tyson Murdock; and is soon to be CFO, James Lucania. Before I turn the call over to Jon, I have 2 important reminders. A press release announcing the financial results for our second quarter of fiscal 2024 was issued after the market closed this afternoon. These financial results include the contributions from our wholly owned subsidiaries and accounts that 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, September 5, 2023, and will contain forward-looking statements as defined by the SEC, which include 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 risks and uncertainties that may cause the 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 they are detailed in our latest 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. One more note before turning this over to Jon, which you now on board, we have rescheduled our Draper Investor Day to February 22. We’re hoping for another great year of snow for those who want to ski on the greatest snow on earth. And we hope all will join us either in person or virtually.

Over to you, Jon.

Jon Kessler: Okay. Hi, everyone, and thank you for joining us. I will discuss Q2 key metrics and management’s view of Kirk conditions. And Tyson will touch on Q2 results before detailing our raised guidance for fiscal ’24, and Steve is here for Q&A. In Q2, the team delivered double-digit year-over-year growth in revenue, which was plus 18%; and adjusted EBITDA, which was plus 31%, HSA assets grew 13% and HSA members grew 9%. Total accounts grew 3% muted by the previously discussed change in COBRA methodology. HealthEquity ended Q2 with 8.2 million HSA members, $23.2 billion in HSA assets and 15 million total accounts. The team added 156,000 new HSA members in its fiscal second quarter, which is healthy, but down from the record setting Q2 last year.

As in Q1, comparison to last year’s blistering job growth and high turnover as well as fewer — he transfers from small banks were offset by robust new logo growth driven by an expanded network partner footprint and HR departments seeking out win-wins. The team also added $883 million in HSA assets in Q2. I wanted to say a whopping 883, but I wasn’t allowed to. So I didn’t say that. That’s compared to a $272 million increase in the year ago period, which would not be as swapping, reflecting not only count growth but also balance growth. Despite inflation, average HSA balances at HealthEquity grew both sequentially and year-over-year, in part due to investment. 11% more of our HSA members became investors year-over-year, helping to drive up invested assets by 23%.

Remarkably, invested assets now account for 40% of HSA assets. We continue to see more members choose enhanced rates for their HSA cash, leading to higher for longer custodial yields and we believe less cyclicality in the future. Interest rates in Q2 also gave a boost to variable rate HSA cash and CDB client funds. While custodial fee growth drove Q2 performance, the team also delivered modest progress on service fees, the bulk of which come from ancillary CDP administration products. Service revenue rose 3% year-over-year, in line with total accounts. Service costs grew just 2% year-over-year and declined sequentially by more than $4 million. As we discussed last quarter, rapid improvement in service tech continues to drive more interactions to chat and automated responses.

The runout of remaining tailwinds from the COVID-19 national emergency may obscure a bit the progress that we’re making when we get to the second half, but we see the results we’ve delivered here in Q2 as well as in the first quarter as evidence of positive trajectory on service revenue and margin. Finally, interchange revenue, which resumed its seasonal pattern as expected, with strength in Q1 followed by a more subdued performance in Q2. We think the HSA market HealthEquity now leads can grow by about 10% annually for years to come, thanks to steady account growth and faster asset growth as accounts mature, which in turn expands margin opportunity. Team Purple can extend its long record of outperformance by doing what it did well in this second quarter.

Before turning the call over, I would like to publicly thank Mr. Tyson Murdock for his unwavering service to HealthEquity’s mission, vision and values over the past 5.5 years. And in particular, for focusing his team on a strong finish and a smooth transition over these past few months. Pason’s a class act, and you would do well to keep an eye out for the opportunity in whatever he chooses to do next. As Richard noted at the top of the call, Jim Lucania who will take over as CFO effective tomorrow, is with us today. Jim will be active on the conference circuit this fall, beginning tomorrow actually. And of course, will preside at HealthEquity’s Investor Day in Utah in February, as Richard mentioned.

Tyson Murdock: All right. Thank you, Jon, for those kind of comments. All right. I’ll highlight our second quarter GAAP and non-GAAP financial results. A reconciliation of GAAP measures to non-GAAP measures is found in today’s press release. Second quarter revenue increased 18% year-over-year. Service revenue was $105.7 million, up 3% year-over-year. The total revenue grew 51% to $98.9 million in the second quarter, and the annualized interest rate yield on HSA cash was 237 basis points. Interchange revenue grew 4% to $38.9 million. Gross profit as a percentage of revenue was 62% in the second quarter of this year versus 57% in the year ago period. This is the highest gross margin quarter since we acquired WageWorks 4 years ago.

Net income for the second quarter was $10.6 million or $0.12 per share on a GAAP EPS basis. Our non-GAAP net income was $45.6 million for the second quarter, and non-GAAP net income per share was $0.53 per share compared to $0.33 per share last year. While higher interest rates increased custodial yields and generated interest income, they also increase the rate of interest we pay on the remaining $287 million Term Loan A to a stated rate of 6.9%. Adjusted EBITDA for the quarter was $88.1 million, and adjusted EBITDA as a percentage of revenue was 36%, a more than 360 basis point improvement over last year. For the first 6 months of fiscal ’24, revenue was $488 million, up 18% compared to the first 6 months of last year. GAAP net income was $14.7 million or $0.17 per diluted share, and non-GAAP net income was $88.4 million or $1.02 per diluted share, up 74% compared to the same period last year.

And adjusted EBITDA was $174.7 million, up 39% from the prior year, resulting in adjusted EBITDA as a percentage of revenue of 36% for the first half of this fiscal year. Turning to the balance sheet. As of July 31, 2023, cash at quarter end was $290 million, boosted by a record $77 million of cash generated from operations in Q2 and $109 million year-to-date. The company had $874 million of debt outstanding net of issuance costs, and 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 the range between $980 million and $99 million, GAAP net income to be in a range of $19 million to $24 million. And we expect non-GAAP net income to be between $171 million and $179 million, resulting in non-GAAP diluted net income between $1.97 and $2.06 per share based upon an estimated 87 million shares outstanding for the year.

We expect adjusted EBITDA to be between $338 million and $348 million. Our $5 million midpoint revenue increase is primarily based on revised expectations for the average yield on HSA cash to approximately 240 basis points for fiscal ’24. As a reminder, we base interest rate assumptions embedded in guidance on an analysis of forward-looking market indicators such as the secured overnight financing rate and mid-duration treasury forward curves and Fed funds futures. These are, of course, subject to change. Our expectations are tempered somewhat by the anticipated impact of the end of the national emergency period that Jon referenced in his remarks on service revenue. Average crediting rates our HSA members receive on HSA cash remained flat sequentially and the crediting rates our HSA members received are determined in accordance with the formula described in our custodial agreements with them.

We continue to expect these rates will rise as overall interest rates remain elevated and have included in our guidance, a 5 basis point increase by the end of fiscal ’24. 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. And then we assume their projected statutory non-GAAP 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. As we have discussed, moving to positive GAAP net income impacts our GAAP tax rate strangely this year. Discrete tax ends may also impact the calculated tax rate on a low level of pretax income.

Based on our current full year guidance, we expect roughly a 50% GAAP tax rate for fiscal 2024. As we have done in recent reporting periods, our full fiscal 2024 guidance includes a reconciliation of non-GAAP to the non-GAAP metrics provided in the 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 intangibles is being excluded from non-GAAP net income, the revenue generated from those acquired intangible assets is not excluded. My time serving our members, our teammates and investors over the last 5.5 years has been a real pleasure. We made a lot of progress, and I’m confident the team will continue the course as I’ve driven to my next opportunity.

And with that, we know you have a number of questions. So let’s go right to our operator for Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions] Today’s first question comes from Greg Peters at Raymond James.

Greg Peters: I guess before I begin with my question, Tyson, I’d also like to congratulate you on your service and health equity, certainly help compete to some challenging times. Jon, in your prepared remarks, you mentioned something about sustaining a 10% growth. And I was just curious about your perspective of the macro environment from a competitive standpoint. You’re seeing numbers from Dubner and others just and some are having some success, maybe as much success in growing share as you are, while others are not. Just an updated view on how the market looks to you today.

Jon Kessler: Well, I think if you sort of think about where the market is, you have two factors that ultimately drive revenue growth, which is the first thing that as investors we care about. The first is account growth and the second is asset growth. And account growth in my view, will — if I look at it on a multiyear basis, we’ll kind of be in the high single digits and asset growth will be in the teens. And revenue growth is typically somewhere between the two. I think — and I don’t really see any reason for much change in that view based if I’m trying to ask the question over multiple years. And then look, our job is to outperform the market in terms of assets, accounts, et cetera, and then to do a better job, the best job we possibly can and hopefully a better job than others at generating both revenue and profitability from doing so.

Greg Peters: All right. My detail — my follow-up detailed questions on free cash flow. Nice improvement on a year-over-year basis, it looks like the gap between adjusted EBITDA and free cash flow is narrowing. Maybe you can just update us on how you’re looking at free cash flow for the balance of this year? And are there any headwinds that we should be thinking about with free cash flow as we think out beyond this year?

Jon Kessler: Maybe Tyson, would you mind starting with regard to the sort of balance of this year question? Anything in particular that — I think the quest gist of the question is, was there some jump forward or the like?

Tyson Murdock: No. I mean I think this is to be expected as the custodial revenue increases with the very high margin and cash generation capability, we know that it’s going to accelerate that cash. And as you see, the positive GAAP net income come in, it’s overcome now all the amortization from the wage works and other deals that are in there. So the business is starting to pure on that generation of custodial cash and I’d expect that to continue going forward. Of course, the one — there’s other — there’s things in there like we’re going to start to pay taxes. So you got wires going out for taxes, you can see that in there. And other than that, I think the other things that are in there, like property, plant and equipment purchases and just what we spend on tech and things like that. There isn’t huge changes in there that would cause other things to occur. So it’s going to continue to and move up.

Jon Kessler: And Greg, as far as use of cash, we’re — first of all, it’s worth noting that if we do nothing, over the course of multiple years here, and it’s not too many. The free cash flow is basically going to eliminate our leverage. And we’re very comfortable with current leverage. I don’t don’t want anyone to take my statement as suggesting otherwise. But that’s probably not what’s going to happen, meaning we probably will want to look at using that cash and — or we will want to look at using that cash as we have in recent quarters. And from my perspective, in terms of order of cash utilization, there’s portfolio transactions that we like because they are reliable ROI. And then we’ve paid down a little bit of our term A.

I would expect that where portfolio transactions aren’t available or where it makes sense at some point, we’ll continue to do that. And then, it’s worth noting that within the current envelope, we’ve committed to investing in organic innovation. And you’re starting to see pieces of that come through. You will see more pieces of it come through. And it’s, I think, helpful when we get a question, as I’m sure we will later about T&D expense and the like that we’re able to do that within the envelope we have and ultimately, while bringing T&D expense as a percentage of revenue down over time.

Jon Kessler: Thanks, Greg. Have a safe light.

Operator: And our next question today comes from Stan Berenshteyn with Wells Fargo.

Stan Berenshteyn: Thanks for going to answer my questions [ph]. On a personal — not yet, not yet, although I’d like to. But I would like to say on a personal note, Tyson has been a pleasure working with you. Maybe a couple of questions. First one on your sales pipeline. Any changes in the RFP volumes you’re seeing? Any changes in your win rates or perhaps what employers are looking for?

Jon Kessler: Yes. Probably the most notable thing we’ve seen Stan this year is — I mean, let me back up and say, generally, the commentary I would give on account growth is that, on the one hand, and similar to what we said in the first quarter, on the one hand, you’ve got the sort of less tailwind from a macro perspective, new job creation and so forth. And then on the other hand, we are seeing higher new account onboarding and then more importantly, the sort of pipeline and start work for fiscal Q4 calendar January build. And the source of that bill is — so that’s all providing a bit of an offset. And I think when I look at the pipeline, what’s interesting this year is for the first time since the pandemic, the enterprise pipeline has been very robust.

And I’m not prone to like give answers without data. One answer that is given is okay. People now have the space to make changes that they weren’t willing to make. That’s certainly possible. But in any event, it is worth noting that I think the biggest thing I would note that’s different is the volume of enterprise deals that we are seeing and that are turning out not to be just price checks or whatever we’re able to win business away from competitors as well as greenfield business.

Stan Berenshteyn: Got it. That’s helpful. And then one more on custodial assets. Can you get an update on the current mix of assets that are in enhanced yields? And where do you expect that mix will be 12 months from now?

Jon Kessler: So we’ve given guidance for the guidance is maybe the wrong word. We’ve said that I listen, I pay attention. Richard has given me a face. This is what I get for being here. You — so we said that we’ll hit about 30% by the end of the year, and I think we’ll end up doing a little better than that. It is true that at this point, one of the limiting factors that we’re working with is the timing of roll-off of our deposit contracts and the like that are also barriers as well as appropriate education of consumers. So I guess I would say that in general, the enhanced rates program is moving at or above the pace we have discussed. And we think that the end result of this is going to be both a higher for lack before neutral rate as well as ultimately less cyclicality because of the features that we’ve been able to to design into this product.