HealthEquity, Inc. (NASDAQ:HQY) Q3 2023 Earnings Call Transcript

HealthEquity, Inc. (NASDAQ:HQY) Q3 2023 Earnings Call Transcript December 7, 2022

Operator: Good day, and welcome to the HealthEquity Third Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Richard Putnam. Please go ahead.

Richard Putnam: Thank you, Sarah. Happy holidays to everybody, and welcome to HealthEquity’s third quarter fiscal year 2023 earnings conference call. My name is Richard Putnam. I do Investor Relations for HealthEquity. Joining me today is Jon Kessler, President and CEO; Dr. Steve Neeleman, 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 third quarter of fiscal year 2023 was issued after the market closed this afternoon. The financial results in the press release include the contributions from our wholly-owned subsidiary, WageWorks and accounts it administers.

The press release also includes definitions of certain non-GAAP financial measures that we will reference here 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, December 6, 2022 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 risks and uncertainties that may cause the actual results to differ materially from the statements made here today. We caution you 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 which are detailed in our latest Annual Report on Form 10-K and also 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, and Sarah will help us with that process.

So let’s get started by turning the call over to our CEO, Jon Kessler.

Jon Kessler: Thank you, Richard. Hello, everyone, and thanks for joining us this afternoon. Today, we are announcing strong results for HealthEquity’s fiscal 2023 third quarter. We are raising our full-year outlook for fiscal 2023 and we are providing an early view to fiscal 2024. I’ll discuss Q3 operating results. Tyson will review the financial results in detail and provide updated guidance. And Steve is here for Q&A. Let’s start with reviewing the five key metrics that drive our business. Revenue of $216.1 million in the quarter grew 20% versus the third quarter of last year. Thanks to strong growth in HSA members, their assets and improving custodial yields and the inclusion of the acquired further business. Adjusted EBITDA of $73.4 million also grew 20% versus the third quarter of last year, reflecting revenue growth.

Total accounts grew to $14.5 million, up 9% compared to last Q3. HSA members reached $7.7 million, up 23% year-over-year, and HealthEquity HSA members grew their assets to $20.2 billion at quarters end, which was also up 23% from a year-ago. Team Purple continued its strong FY2023 sales effort, adding 170,000 HSAs, up 13% from 151,000 new HSAs opened in Q3 last year. Organic account growth of 12% over the last year as well ahead of the market’s 9% growth reported in Devenir’s mid-year assessment, which was published in September. As we complete open enrollment, we are particularly excited about what appears to be a strong showing from our network partners and conversion of enterprise cross-sell opportunities, as well as increasing usage by our enterprise clients of our MaxEnroll engagement prop.

Continued volatile market conditions contributed to a sequential decline in HSA invested assets of $333 million in a quarter, even while HSA investing members grew 23% year-over-year and continued to fund their HSA investments. The average HSA balance of our members increased slightly year-over-year. Custodial revenue growth was very strong with higher than expected custodial yields in the quarter, driven by robust adoption of HealthEquity’s enhanced rates offering and the actions of Federal Reserve. We continue to build our enhanced rates partnerships, which will allow us to further grow HSA cash balances in that product adding to yields in the future. Today’s results and the guidance Tyson will detail in a moment, include the softness in CDB administration services that we highlighted last quarter.

Year-to-date service fees from CDBs themselves declined in fiscal 2023 versus the same period in fiscal 2022. However, with commuter growth and partially recovering some of the FSA revenue attrition we saw earlier in the year in Q3, we are reporting a sequential and year-over-year increase in service fees. Excluding COBRA accounts, CDB accounts grew 3% and we remain optimistic that our CDB services can continue to grow. With that, I will turn the call over to Tyson for more details. Tyson?

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Tyson Murdock: Thank you, Jon. I’ll review our third quarter GAAP and non-GAAP financial results. A reconciliation of GAAP measures to non-GAAP measures is found in today’s press release. Third quarter revenue increased 20% year-over-year led by robust custodial revenue growth. Service revenue was $108.6 million, up $5.8 million or 6% year-over-year. Q3 service revenue growth included an uptick in commuters returning to work and a small increase in FSA and continued softness in COBRA revenue, as Jon mentioned. Please note that we made an adjustment in how we calculate COBRA accounts resulting in a $0.2 million sequential reduction in COBRA contribution to total accounts, but with no material impact on revenue or expense. Custodial revenue grew 52% to $74.6 million in the third quarter, benefiting from growth in average HSA cash combined with an uptick in annualized yield on HSA cash, partially offset by a decrease in average HSA investments.

The annualized interest rate yield on HSA cash was 200 basis points during the third quarter of this year, and 183 basis points year-to-date compared to 172 and 176 respectably for last year. This yield is a blended rate for all HSA cash during the quarter and represents a better than expected deal due to rate hikes benefiting the variable rate portion of our HSA cash combined with higher enhanced rate balances in the quarter. HSA assets payable of today’s press release provides additional details. Interchange revenue grew 16% to $32.9 million compared to $28.2 million in the same quarter last year. Year-over-year growth in Q3 benefited from growth in average total accounts with cards and increased spend per account. Gross profit was $126.9 million compared to $103.3 million in the third quarter of last year.

Gross margin was 59% in the third quarter this year versus 57% in the year-ago period, benefiting from increased custodial revenue and reflecting the efforts we discussed last quarter to control service costs and improve margins. Operating expenses were $121.3 million or 56% of revenue, including amortization of acquired intangible assets and merger integration expenses, which together represented 14% of revenue. Operating income was $5.5 million in the third quarter compared to a loss of $0.4 million in the third quarter last year. Net loss for the third quarter was $1.6 million, or a loss of $0.02 per share on a GAAP EPS basis compared to a net loss of $5 million or $0.06 per share in the prior year. Our non-GAAP net income was $32.4 million for the third quarter this year compared to $28.9 million a year-ago.

Non-GAAP net income per share was $0.38 per share compared to $0.35 per share last year. Higher interest rates also increased the rate of interest we pay on the remaining $343 million term loan A with the current effective rate of 6.38%. Adjusted EBITDA for the quarter was $73.4 million, and adjusted EBITDA margin was 34%. For the first nine months of fiscal 2023, revenue was $627.9 million, up 13% compared to the first nine months of last year. GAAP net loss was $25.9 million or $0.31 per diluted share. Non-GAAP net income was $83.2 million or $0.99 per diluted share, and adjusted EBITDA was $198.7 million, up 7% from the prior year, resulting in 32% adjusted EBITDA margin for the first nine months of the fiscal year. Turning to the balance sheet.

As of October 31, 2022, we have $210 million of cash and cash equivalents with $927 million of debt outstanding net of issuance costs. This includes the $343 million of variable rate debt. There are no outstanding amounts drawn on our $1 billion line of credit. We are providing the following updates to our guidance for fiscal 2023. We are increasing our revenue estimates for fiscal 2023 to range between $850 million and $860 million. We expect our GAAP net loss to be in a range of $34 million to $27 million. We are increasing non-GAAP net income to be between $106 million and $114 million, reflecting increased interest expense, partially offsetting the benefit of higher operating income, resulting in non-GAAP diluted net income between a $1.26 and $1.35 per share based upon an estimated 84 million shares outstanding for the year.

We are raising our adjusted EBITDA estimate to be between $261 million and $271 million. Today’s guidance includes our most recent estimate of service, custodial and interchange revenue and expenses based on results today. On service revenue, today’s guidance reflects continued solid performance of core HSA offering offsetting the full-year impact of FSA and COBRA service fee headwinds observed year-to-date. We remain cautious on increased commuter uptake. Based on the strong sales outlook, Jon discussed and continuing labor market tightness, today’s guidance assumes incremental service cost during Q4 comparable to those experienced last year. On custodial revenue, today’s guidance assumes a full-year yield on HSA cash of approximately 190 basis points based upon current conditions and expected HSA cash placements in the fourth quarter.

Our guidance for this year does not assume additional increases or decreases in the overnight Fed funds rate or other changes in macroeconomic policy for the remainder of the fiscal year. Our guidance reflects the continued shift of our HSA members building and moving HSA assets to investments. Nonetheless, with current rates rising, our market-driven formula push the interest rate that we pay our members on their HSA cash balances up 5 basis points for the upcoming fourth quarter this year. We expect increases of a similar magnitude will continue over time under current conditions. In the same vein, today’s guidance reflects additional interest expense for HealthEquity’s variable rate debt for the remainder of fiscal 2023 based on current conditions without factoring in additional overnight Fed funds rate hikes for the remainder of the year.

We assume a projected statutory income tax rate of approximately 25% and a diluted share count of $84 million. We are also providing the following initial guidance for fiscal year 2024. We expect revenue to be between $950 million and $970 million. We expect margin will expand with adjusted EBITDA growing to approximately 33% to 34% of revenue in fiscal 2024. This initial guidance is based on an estimated HSA cash yield of 225 basis points based on our view of interest rate conditions during that period. Today’s guidance does not include any additional portfolio acquisitions in fiscal 2023 or 2024, and reflects anticipated inflationary impacts on costs, including continued higher interest rates paid HSA members and healthcare usage rates reported in this quarter, and included in our fiscal 2023 guidance.

As we’ve done in recent reporting periods, our full fiscal 2023 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 intangibles is not excluded. However, a reconciliation of our adjusted EBITDA outlook for the fiscal year ending January 31, 2024 to net income is most directly comparable GAAP measure is not included because our net income outlook for this future period is not available without unreasonable efforts as we are unable to predict the ultimate outcome of certain significant items excluded from this non-GAAP measure, such as depreciation and amortization, stock-based compensation and income tax provision or benefit.

With that, I will turn it over to Jon. Thanks.

Jon Kessler: Part at the end is good. It was good. I’d like to close the formal part of this by thanking our individual contributors both at HealthEquity and from our clients and partners that have to date delivered a Team Purple open enrollment season, are finishing that up and getting ready to deliver an equally impressive onboarding season in January. It’s their work that has set us up for what we expect to be a very busy and productive end of this year and as Tyson has indicated a very healthy next year. And so I thought it was appropriate just to say thank you. With that, let’s open the call up to questions. Operator?

Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. Our first question comes from Stephanie Davis with SVB Securities. Please go ahead.

Jon Kessler: Hi, Stephanie.

Stephanie Davis: Hey, guys. Thanks so much for taking my questions. Appreciate it. I was a little surprised to see preliminary guidance this soon, one; and two, see the preliminary guidance factors in what feels like a relatively conservative yield assumption. So I was hoping you could tell us a little bit more about the decision process and what weighs into all of that?

Jon Kessler: Tyson, do you want to speak to the reason to do guidance?

Tyson Murdock: Yes. Hey, Stephanie, good to hear from you. We wanted to get guidance out a little bit earlier this year just to give people a view into next year based on the conversations that we’ve had about placements and those type of things. One thing to keep in mind directly to your question on yield is, we’re estimating that based on our current view of what the consensus says about the macro economy. And the other thing, Stephanie, that’s important to keep in mind on that is that we’re going to have a lot less variable cash €“ HSA cash as well. So there won’t be as much impact from that. It’s kind of been a very different year in fiscal 2023 with the Fed rate movements moving that yield up and then subsequently having us raise guidance based off of that.

We’re doing it a little bit different this year with regards to the fact that there’s less of that cash there because we’ve been able to place it due to the demand and then also just considering the way that we’re actually doing guidance, we’re trying to get a wholesale view on the year.

Stephanie Davis: So thinking about the kind of delta and guidance philosophy between FY2024 versus FY2023, is it safe to just assume that you’re not assuming as much potential upside? Or is there anything else to call out an enhanced rate floating, all the other toggles have been so beneficial this year?

Jon Kessler: Well, I mean, if you look at it from a midpoint-to-midpoint perspective, Stephanie, we’re forecasting double-digit topline growth and profitability on an EBITDA basis that’s like twice as fast €“ with EBITDA growing twice as fast as that give or take. And

Stephanie Davis: I know it’s like a pump bringing this up and being like it’s not high enough guys. What is that?

Jon Kessler: Right, right. So like €“ I’m kind of like €“ we felt like this will be the first time we’ve ever given guidance ahead of the year. The reason that we’re doing that is as Tyson suggested is, one, because we have a great deal of confidence in the year; two, because we have great deal of visibility; and three, to set a baseline. And we’ll have plenty of opportunities to take more bites at this apple and we’ll see how both, obviously, our sales season finishes up. In the past, we’ve, I think, generally underpredicted our sales season which is sort of how we do things, as you know. But we’ll see how our sales season finishes up. We’ll see how things like FSA enrollment finishes up. Obviously, we’ll see what happens in the broader economy. But we thought that set a pretty darn healthy baseline for going into fiscal 2024.

Stephanie Davis: Well said. Thank you, Jon.

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

Anne Samuel: Hi, guys. Thanks for taking the question, and thanks for providing the guidance. Really helpful. I was wondering if maybe you could talk about how your selling season is shaping up this year, and just what conversations with your customers are like, just given the current macro environment?

Jon Kessler: Steve, do you want to hit this one?