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spk12: And welcome to the Health Equity Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Richard Putnam. Please go ahead.
spk08: Thank you, Sarah. Happy holidays to everybody, and welcome to Health Equity's third quarter fiscal year 2023 earnings conference call. My name is Richard Putnam. I do Investor Relations for Health Equity. Joining me today is John Kessler, President and CEO, Dr. Steve Neelaman, Vice Chair and Founder of the company, and Tyson Murdoch, the company's Executive Vice President and CFO. Before I turn the call over to John, I have two important reminders. First, the 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, WeightWorks, and accounts it administers. The press release also includes definition 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 against placing undue reliance on these forward-looking statements. We also encourage you 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. call over to our CEO, John Kester.
spk02: Thank you, Richard. Hello, everyone, and thanks for joining us this afternoon. Today, we are announcing strong results for health equity's fiscal 2023 third quarter. We're raising our full-year outlook for fiscal 2023, and we are providing an early view, that's a preview to some, 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 health equity HSA members grew their assets to $20.2 billion at quarter's end, which was also up 23% from a year ago. Team Purple continued its strong FY23 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 is well ahead of the market's 9% growth reported in Devonier's mid-year assessment, which was published in September. As we complete open enrollment, we're 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 max enroll engagement product. Continued volatile market conditions contributed to a sequential decline in HSA invested assets of $333 million in the 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 health equity's enhanced rates offering and the actions of the 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 23 versus the same period in fiscal 22. 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.
spk17: Tyson. Thank you, John. 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. and a small increase in FSA and continued softness in COBRA revenue, as John 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. The custodial revenue grew 52% to 74%, 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, respectively, for last year. This yield is a blended rate for all HSA cash during the quarter and represents 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 Operating expenses were 121.3 million, Non-GAAP net income was $32.4 million for the third quarter of 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 aid. 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 31st, 2022, we have $210 million of cash in cash or 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 23. We are increasing our revenue estimates for fiscal 23 to range between $850 and $860 million. We expect our gap net loss to be in a range of $34 million to $27 million. We are increasing non-gap net income to be between $106 million shares outstanding for the year. We are raising our adjusted EBIT estimate to be between $261 and $271 million. 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. We are also providing the following guidance. As we have done in recent reporting period 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.
spk02: Part of 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 deep 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's 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?
spk12: Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Stephanie Davis with SVB Securities. Please go ahead.
spk18: Hey, guys. Thanks so much for taking my question. Appreciate it. I was a little surprised to see preliminary guidance this soon, one, and to, 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.
spk02: Vincent, you want to speak to the reason to do guidance?
spk17: Yeah, yeah. Hey, Stephanie, good to hear from you. 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 23 with the Fed rate movements moving that yield up and then subsequently having us rate
spk18: 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 so thinking about the kind of delta and guidance philosophy between FY24 versus FY23 is it safe to just assume that you're not assuming as much potential upside or is there anything else to call out in enhanced rate floating all the other toggles that have been so beneficial this year
spk02: Well, I mean, if you look at it from a midpoint to midpoint perspective, Stephanie, we're forecasting double-digit top-line growth and profitability on an EBITDA basis. I know.
spk18: It's like a punk bringing this up and being like, it's not high enough, guys. What is this?
spk02: Right, right. So 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, as Tyson suggested, is one, because we have a great deal of confidence in the year. Two, because we have a 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 under-predicted 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 this set a pretty darn healthy baseline for going into fiscal 24.
spk18: Well said. Thank you, John.
spk12: Our next question comes from Anne Samuel with JP Morgan. Please go ahead.
spk01: Hi, guys. Thanks for taking the question and thanks for providing the guidance. Really helpful. I was wondering if maybe you could talk about, you know, how your selling season is shaping up this year and just what conversations with your customers are like just given the current macro environment.
spk02: Steve, you want to hit this one?
spk07: Sure. Yeah, look, I mean, I was in the field yesterday with a bunch of our sales leaders and one of our partners, and I think there's some real genuine enthusiasm in the way that the year is finishing up. Just, you know, as you know, we – was so unsettled over the last two or three cycles because of everything that's going on in the economy. Now, of course, there's concern about the upcoming recession and whether that may impact some cells, but I can tell you that both from our direct cells to clients and ourselves through our partners, our health partners and other partners, and then even we mentioned a little bit in prepared remarks about this maximum role process, but I think we're really kind of excited with the way the year's I turn it out and obviously won't know all the numbers. We say this every year at this time until we're actually close to January. And last January was such a bumper crop year that we've got a lot of work to do to even get those numbers, but we're feeling pretty good about the year.
spk01: That's great to hear. Thanks. And then I was hoping maybe just one on the enhanced rate products. How should we be thinking about that yield relative to your overall yield? And how should we be thinking about what the contribution was to the yield that you guided? I think last year, 10% penetration gave you about 10% yield.
spk02: Yeah, we previously said that our goal was to get to about 20% penetration by the end of the year, and that we felt like we were likely to exceed that. And I still think that's true. So it did make a contribution. And as we've talked about before, the enhanced rate product produces gross yield that's, give or take, and we've talked about this before, maybe a 75-ish basis point premium to what we're seeing from our deposit products. And so, you know, I think you can kind of do a little bit of math from there. The way we look at it, though, one of the biggest – well, two thoughts. One is we have a long way to go with this. This is going to be a benefit to – this is going to be a tailwind for us for many years to come. As Tyson commented, you know, we've added incremental partners this period to the enhanced rates product, sort of the equivalent of adding banks in the early days on the deposit side. And, you know, that's just a good thing, both in terms of aggregate rates, but I think also in terms of stability, you know, as you see all this kind of variability on rates back and forth. So it helped us a little bit going into fiscal 24. It helped us a little bit in fiscal 23. I mean, you'll recall at the start of the year, we were, you know, what were we guiding to at the start of the year? 150 basis points in fiscal 24. Sir Richard. And so it helped us along with the Fed's actions this year. And again, whatever the Fed does, this will continue to be a nice tailwind for us for a long time to come.
spk01: That's really helpful, caller. Thank you.
spk19: Thank you. Thanks, Anya.
spk12: Our next question comes from Greg Peters with Raymond James. Please go ahead.
spk10: Mr. Peters. Good afternoon, Team Purple, and Sir Richard. I guess the first question I wanted to ask is about just the HSA total assets that you reported as of October 31st, 2022. In the press release, you commented on the growth on a year-over-year basis, but if I look at the number relative to where it was on January 31st, 2022, it's not growing as fast. So, maybe you can speak to the cadence of total HSA asset growth.
spk02: Yeah, the primary factor that has been driving the deceleration in asset growth during the, on a sequential basis, has really been, you know, something we commented on in the text, and that's a decline in asset values over the period. So, I think we actually tried to quantify that a little bit in the text. What I guess I would say is remarkable and helpful is that during that period that we haven't seen fundamental changes in consumer contribution behavior or the like. I do think there's been a little bit of kind of thing but but that that is very modest and the biggest effect that we've seen there is is you know market and asset values and those have a way of as you well know you know kind of reverting to a mean so we're just going to keep trying to do our thing and I think over time now that'll work itself out just fine okay and then and then I guess my follow-up question from a macro perspective
spk10: You know, last time rates started to move up, which was some time ago, you know, we started to see some changes in competitive behavior around their attitudes of service revenue versus custodial revenue versus interchange. And I thought I was just wondering if there's been any noticeable change in the competitive landscape favoring custodial versus service, considering the movement in rates, etc.? ?
spk02: I'd like to believe, Greg, that people have gotten a lot smarter about this, recognizing that rates go up and rates go down. What I do think is the case is that if you look at this, let's say, three, well, certainly at the start of the pandemic, as you'll recall, I remember you asking a question about negative a normalized rate environment looks like actually is probably not you know it's it's you know it's it's a you know it's clearly it ain't zero it ain't one it ain't two and so I think people kind of understand that a little better and so we're not seeing quite the same you know sort of I'm going to call it where some people were like, oh, this is going to last forever. Let's do X, Y, or Z on five-year agreements. But it's a piece of the puzzle in terms of aggregate service fees. I also point out, too, that, as you know, but others might not, our service fee revenue today comes primarily from our CDB products. Our HSA service revenue on a year-over-year basis is CDB is where we've been more challenged, as we discussed last quarter and the quarter before, which is not fundamentally about competition. It's fundamentally about some of our challenges as we finished up the CDB side of the wage works migration. But look, I've always said there's some level of, for lack of a better term, elasticity between service fees and rates. But I do think people are a little bit, let's say, I think a little bit smarter about the fact that, you know, that they have to look at normalized rates over an extended period of time as opposed to, you know, what yesterday's Fed funds rate was.
spk19: Okay, got it. Thanks for the answers. Thank you.
spk12: Our next question comes from Glenn Smith. Sant'Angelo with Jefferies. Please go ahead.
spk16: Hey, how are you guys doing? Thanks for taking my question. Hey, John and Tyson, I just wanted to unpack this 24 guidance in a little bit more detail. If you look at sort of these third quarter results, you put up a 34% gross margin, and, you know, your initial – fiscal 24 guidance is calling for an EBITDA margin of 33 to 34. So it looks like it takes a little bit of a step back, which is a little bit surprising just given the growth in the custodial revenues and given the gross margins around that custodial business. So, you know, Tyson, I was wondering if you could unpack, you know, the margins a little bit and give us a sense for what you're assuming in 2024, because I don't know if it's pricing. I don't know if it's mix of business lines that, that may be driving that margin one way or the other. Thanks.
spk17: Yeah, I mean, the first thing to really keep in mind, I mean, one thing, just go look at last year's Q4 and just the seasonality of our business. And so when you look at, if you back into the margin for Q4 of last year, you know, that's essentially 25% they've been pretty much equivalent in the Q4 time period as to what they were last year as far as that increase that happens between Q3 and Q4. So blending the quarters together, Q3 is always going to be a strong EBITDA margin quarter versus Q4 and particularly even Q1 of this year. We talked about some of the service costs that we had blown to that. So when you then blend that together for that guidance for next year, And you think about a 33 to a 34, it's essentially taking up all those quarters, if you will, but still having that same seasonality trending across the respective quarters. Hopefully that helps. Let me just say one of the things. On the implied, guys. I just wanted to make a – you had said gross margin. On the even margin side, it is like, what, 33%? Yeah.
spk08: If you look in our guide right now, it's like 31%, 32% for this year for FY24. So you're looking at like a 200 basis point expansion.
spk02: Exactly. Yeah. I just wanted to make sure that – I mean, that's the core point. We're forecasting in this thing, you know, give or take, depending on, you know, what midpoint, whatever, somewhere between 200 and 300 point expansion in even margins. And – That doesn't seem shabby. It's obviously the case that our view is that we're going to look at how we do this fourth quarter, and that will have some impact on any guidance revisions, as will ultimately unit sales and all that kind of stuff. But similar to Stephanie's question, it seems like a good start.
spk16: Yeah, I think I get it. I just wanted to make sure that I wasn't missing anything. And, John, just another question I wanted to ask you was, You know, for better or worse, many investors are just looking at this stock as a rate trade. I was wondering if you could maybe take a step back and give us some thoughts around these CDB businesses. You know, clearly maybe they've been a little bit slower to recover than what you maybe would have thought. I'm just trying to get your sense for how we think about that on a go-forward basis and how those CDB businesses should impact the growth algorithm in 24 and beyond.
spk02: Yeah, let me first say I think that while I understand why investors may do that, particularly if they're modeling out many years, whatever rate you apply times a corpus of zero equals zero. And mostly what this company has done over the course of time is it has managed to grow the underlying asset base that it manages of what are ultimately a large number of very small accounts, and then in terms of the cash. And so I do think that the first underlying point, before you get to CDBs and all of that, is the underlying growth in what you might think of as units. In this case, units are accounts, HSAs, and dollars. And those have, as we reported, just on their own terms and then relative to market. Specific to the CDB business, first of all, we said at the beginning of the year that we were going to see softness in this business. We talked about basically trying to grow the HSA component of the business to get to a place where by the end of the year it was through So the first point I want to make on this one is that we are very focused on growing the HSA business, which is our core and where we're a market leader. What I think we are on CEBs, and I tried to allude to this in the commentary, is we wanted to get this to a place where it was sort of stable, where we weren't talking about this legislative thing or that. transition thing or that platform thing causing a $5 million surprise here or there. And I think that that's the way I would look at the performance thus far. And the next step in this, in my mind, will be to see what actually we get out of consumer enrollment in the CDB products, particularly the FSA, which is the biggest component of all of that. in the current open enrollment season. The assumption underlying our current look at 24 is, I'm gonna say, I don't wanna say conservative, that's not the right word, but it reflects what we've seen to date. But we'll see what we actually get and we'll be able to talk about it at JPM in a few weeks and then ultimately refine our guidance accordingly. But I think that's the next step is to see enrollment growth at the consumer level. And we've done some things this year that really should help us there around how we engage with consumers that, you know, kind of maybe their egg got scrambled a little bit on this one during the pandemic. And we're hoping to see real benefits from that, but I want to actually see them first before I project them.
spk16: Okay. Thanks for all the details.
spk19: Thank you.
spk12: Our next question comes from Scott Schoenhals with KeyBank. Please go ahead.
spk09: Hi, John and team. Apologies, I'm fighting cold here. Apologies for the nasal voice.
spk02: They always say it's a cold, but you never know. That's the problem. Everyone says it's a cold or allergies or something. You're on the phone, so I guess it's okay.
spk09: I tested negative so far. We'll see what it develops into. Put it on the web.
spk02: We want to see it. I'm kidding.
spk07: By the way, RSVD works over at this point. Yeah. We want a full battery of tests. All right, go ahead. Go ahead, son.
spk09: And I did pick this up from my daughter at daycare, so it might be RSVD. But anyway, I'm not going to ask you a question about rates. I just wanted to talk about the interchange revenue. It came down 12% sequentially. I think that's more than normal trends. Um, what's driving that? What are you seeing so far in November and December? I'm just trying to kind of extrapolate the spending behavior, um, from customers on the healthcare system. Obviously it's a broader talking point in healthcare, um, you know, weaker or better than expected volumes heading into this, um, four Q, you know, calendar four Q. So any color would be appreciated.
spk02: Yeah. Um, You know, we're up, let me just say we're up, I want to say 16 or 17%, something like that, year on year. Thank you. And so that's good. But I think you're, you know, typically Q3 is seasonally our softest quarter for interchange revenue. And that was true here. We saw a little, if you look at the different account types, There was a little more softness on the FSA side than in the HSA world. But this is a tough one to predict, and it does bounce around just a little bit to the tune of a couple hundred thousand dollars here or there in either direction in a given month. So that's kind of my thought about it. I mean, ultimately, what's going to drive interchange over the long term is is having more accounts and having people comfortable contributing to those accounts, and that's what ultimately they're spending, if that makes any sense. But Tyson, anything to really add to that?
spk17: I don't really have anything to add other than to say I think you're doing some math on that. I don't think it exceeded my expectations by any means, and I think it was maybe a little lighter, but I think it was well within the window of how I think about forecasting and things like that, Scott. I didn't see anything particularly other than what John mentioned there. I mean, the commuter stuff continued to increase a little bit, so that's always a positive sign that that continues to kind of be a tailwind. That's probably the last comment I'd make on it.
spk09: Okay, great. Nothing to comment. Just my last follow-up, I wanted to go into kind of the self-help story of your margins. Is the further acquisition now complete as we enter the one-year anniversary? Are there any costs that are breaking the guidance at this point? And then secondly, are you guys still consolidating more real estate? Thanks.
spk17: Yeah, on the further one, just to go back to other comments we've made, we still have, you know, the bulk of the synergies are out a couple of years. So when you think about 24 and 25 and getting our arms around, you know, what they did with technology and getting that migrated over onto our platforms and some of those things landed where we really get the synergies out of it, those things remain to be seen. And you can see us kind of spending our way through the $55 million of emanated costs that we said would be there as well as we kind of put that in order. But there will be more synergy out in the future relative to that business. It kind of was a different – usually you might see more up front. This was more of a tail because it's on the technological side.
spk02: And then the second question was – I think was about the real estate that we've been talking about.
spk09: When I was visiting you guys out in person this summer, I saw a lot of consolidation. I was wondering if there was more plans for condensing office space.
spk17: I mean, I think we're in a good spot with what we have. We've got a beautiful building here in Draper and some space down in Texas and largely gotten out of most of the other of it. The stuff you see being backed through EBITDA is really the stuff that relates to wage works, right? It's not everything. And so you can see also in our financials when you look through there that really fixed asset costs are coming down, and we're going to run the business in a much more vertical way, and less capital is always better.
spk02: But if you're interested, we do have some. We do. If you'd like to come out and check it out, again, we can do a full tour. Actually, if anyone's listening to this call, so there is some opportunity there.
spk09: Appreciate that, John.
spk02: We'll see.
spk19: Thanks, Scott.
spk12: Our next question comes from Stan Bernthain with Wells Fargo. Please go ahead.
spk05: Hi, thanks for taking my questions. Appreciate the preliminary guidance you provided. Can you perhaps share with us where are you in the process of actually rolling over into new custodial terms, and when do you expect to be sufficiently completed with that process? And then I have a follow-up.
spk17: Yeah, I mean... It's a good question. When we do this throughout Q4, the assets come in in that end of December, January timeframe when they're actually placed. When you think about them going into, for example, our enhanced rate program and actually starting to derive revenue off of that, it's in the January timeframe that that occurs. Then, of course, we're signing FDIC-type contracts over the course of the last part of December, first part of January timeframe. We kind of get through that by the end of January when we've got all those assets placed and generating revenue.
spk05: Got it. And then for my follow-up, so short-term rates are at 15-year highs, debatable whether we've seen peak rates at this point, but I'm sure John has opinions on that. But I'm just curious, are you inclined at all to increase the duration of your custodial deposits given where rates are versus prior 10, 15 years of history?
spk02: No. Stick to the plan. Yeah. I mean, at this point, I don't think duration is – I mean, you've got an inverted curve. I don't think duration is our friend. But even if it were the normal version, we're basically of the view that you don't pay us to gamble on that, and shareholders don't pay us to gamble on that. We're trying to stay consistent, and there's enough other moving pieces out there.
spk05: Got it. Helpful. Thank you so much.
spk19: Thanks, Dan.
spk12: Our next question comes from Cindy Motz with Goldman Sachs. Please go ahead.
spk00: Hi. Thanks for taking my questions and a nice quarter, and thank you for the preliminary guidance for 24. Did just want to ask a little bit more about, you know, 24 not to beat a dead horse, but is it fair to say that basically what you're doing is – you know, you're anticipating passing through, you know, maybe higher rates or some of the rates and you want to see how it goes in terms of balancing the growth, you know, because obviously you want to, you know, retain customers or, you know, members and, you know, then balance it. But, you know, maybe has it gotten a little more competitive? I mean, is it fair to characterize it like that's what you're doing? And like when you say you're just sort of going to look and see how it goes? Thanks.
spk02: Yeah, it might be worth noting here, with regard specifically to the custodial expense, what we think of as our crediting rates, those are mathematically determined and they're based on what our competitors do there. We have not seen a lot of what one might call deposit beta, nor did we in prior upswings. But there's a little. for the remainder of 23 and 24. I think more broadly, I mean, what we've tried to do is basically reflect our view of the growth that is resulting from the sales cycle that we're now finishing and understanding things like, you know, we're trying to be thoughtful about what the needs of our teammates are going to be as we go into, you know, wage cycle and all that and, you know, try to take what I think is a very sober view of what fiscal 24 might look like and use that as a baseline. That seems like a useful, you know, again, useful thing to do.
spk00: And then just in terms of the overall margin, so that's what we're seeing. There's nothing else going on in terms of you know, other expenses and things like that. It's just basically the mix. And obviously, it's very, you know, strong margin improvement that I guess you, I mean, I know you're not going to give us 25 guidance, but I would expect that that would continue as the mix shifts into 25, maybe similar improvement.
spk02: I think it's, I mean, our general view has been that, you know, as we see mix shift in a number of different ways,
spk17: conclusion would be consistent with that view the only thing I would add to that too just to make a point of it is that the contracts that will replace in fiscal 25 or not this January but next were the contracts that were placed in zero interest rate environment they were negotiated in zero interest rate environment so the brakes stay steady they stay at the averages it'll be an improvement over those contractual placements in that period so there should be accelerated cost side. And it is interesting because we've been in a zero interest rate environment for a long time. And so we saw this move that I pointed out in script that increased the cost by five basis points. That undoubtedly will happen. And again, it's based on that mathematical calculation where we use inputs from what our competitors are doing. And it's right in the small print of the member agreement. And we'll increase that rate as our competitors increase the rate. So
spk15: will happen there great thank you very much thank you our next question comes from George Hill with Deutsche Bank please go ahead George good evening good evening guys I hope you can hear me okay and I hope I'm not about to embarrass myself as I try to do math from the back of a cab but my questions also on the fiscal 24 guide and the rate environment And if I'm doing the math right, your annualized custodial yield this quarter was about 2.3%, and you guys are guiding to 2.25% for fiscal 24. So I guess can you either walk me through the expectation of rate cadence, or should I think of that as conservatism with respect to rates? And I have a quick follow-up.
spk17: All right. I'll give you the correct numbers. I'm watching, Richard, because I was looking at the piece of paper. So for Q3, it was 200 basis points. even for Q3 that we just reported. And then for the annualized number, Richard, was it 190? One annual. Yeah.
spk08: Which implies a little better than like 210 for a Q3.
spk17: Yeah. 190 was our guidance for the full period, right? For the full FY23. Nine months ended, it was 183 or something like that, right? So those are the yields off of this year. So that now for the next annualized period. I think George was including the tip.
spk15: Oh, the tip.
spk08: I mean, it's plus 15%.
spk15: Like I said, guys, math from the back of a cab. I'm sorry about that. And then, John, I'll give you a two-part follow-up, which is, number one, one of your larger competitors in the space seems to be targeting health care financial services as a growing market opportunity, while, of course, that would kind of validate health equity's market opportunity, it seems like they're trying to jam more into their card and what it can do. So I'd love for you to talk a little bit about the competitive environment as it relates to services facing what I'd call the commercial market. And then, John, my joking question was going to be on the real estate that you guys are getting rid of. How close are you guys to go skiing?
spk02: I actually didn't hear that. To go skiing. To go skiing. Yeah, well, I mean, again, we've got very attractive real estate, and I mean, we could chalet this thing if you needed to. We can do it. You can see the snow. We're going to put a tram from the parking lot. We were talking about that earlier today, a tram, like for you. We would do that for you, George. But it's a tenant improvement is what it is. But your first question, what was that first question? Competitor.
spk19: Oh, yeah.
spk02: Competitor environment. I think that there's, Look, my basic view is that there's opportunity there. There's opportunity with regard to how we all think about where we're ultimately headed. And we don't do product announcements and that kind of thing. That's not how we do it. But ultimately, I think you're going to want to think less about the card as a physical piece of plastic. and more as something that's residing in the digital wallets we're all carrying around. And what's nice about that is it does open up some opportunities. That having been said, what we're not going to do is, I do see some of our competitors getting all hot and hungry for the idea of issuing what amounts to high interest revolving credit, And that does not interest us at all. You know, in other words, I'm not – there is a place for that. But I think what we want to do is get to a place where consumers can use these products so they're not putting these things on their consumer credit cards rather than provide more or less the same thing with these plastics. So I guess my basic view is there is opportunity there, and the fact that – And that's where, you know, if you look at what we're looking at in terms of sort of growth revenue streams, I'm sure we'll have more to say about that as time goes on.
spk15: Okay. Thank you, guys.
spk19: Thank you.
spk12: Our next question comes from Mark Markin with Baird. Please go ahead.
spk06: Hey, good afternoon, Team Purple. You know, there's lots of discussion among companies about basically trying to, you know, reduce expenses, you know, increase margins. To what extent does that end up filtering a little bit of the preference, you know, from a healthcare benefits mix over to HSAs? Are you seeing any of that this quarter? And then I've got a follow-up.
spk07: Yeah, thanks, Mark. You know, I think there's always been this probably unappreciated benefit for these types of accounts, even over a 401K, in that the money that people put in out of their own paycheck into a health savings account reduces the employer's cost, not for every one of their employees, but for a big chunk of them, the majority of their employees, by roughly 8%. So if I put $100 in my HSA, my employer saves $8 on payroll taxes, and I save $8 on payroll taxes, plus I save my Fed taxes and my state taxes and all the two states, California and New Jersey. The one where I live, that's the one. John doesn't get his state tax protection. But anyway, so you get a save on taxes, but then we still believe that if you look at plans that have what I would consider to be kind of mass adoption, these health savings account plans, Mark, they just tend to have better trends than plans that are heavier benefited plans that are richer benefits. And so if you can save 2%, 3% on trends, you know, the course of your entire employee base, plus some cash on taxes, it does make sense for you to do that. And so that's why in past recessions, even though, you know, you always hate the thought of folks laying off employees and then that would naturally be our growth or it could impact our growth a little bit, we have seen employers get more aggressive towards going towards successive plans and promoting them. And I think what's different this year In fact, the last couple of years that we've had in the previous 18 years of health equity was we didn't really have the tools to say to an employer, okay, we're going to do this thing, let's go after it. And then to use some of these products we talked about, Max and Roll and RHC Optimizer and just our overall digital marketing effort. So I do think that it's a way for employers that are feeling like, look, I still need to offer our people great benefits. But I need to watch the dollar a little bit more than I did maybe last year to go towards sets of plans.
spk06: Did that help contribute to the $170,000 that you ended up adding?
spk07: Well, I think it was a little earlier. I mean, you know, the recession was, you know, it's not really a recession now, I guess. But, you know, I mean, there's no question that employers are trying to be thoughtful about how they're putting people in benefits. But I think overall the biggest driver for those $170,000 is revenue. employers are figuring out this is actually the richest benefit in kind of an ironic way. I mean, if you can do a well-designed, you know, we've got this Pfizer case study that's out there now, kind of people are reading about it, and, you know, when they, they thought about this thing for 18 years before they did it. Finally, they did it, and they said, we're not doing this as a takeaway. We're doing it because you can leverage a tax code, and you can leverage some other features of this to actually make it the richest benefit. So I think that's, I don't know, John, if you'd agree, but I think more and more recent growth is not I want to save some bucks. It's I want to give the best benefit I possibly can.
spk19: That's great.
spk02: I just think what is true is that we win when our clients on the benefits side need to be creative. Whether it's creative to retain people or creative to manage costs or whatever. Creativity is our friend. This is a cycle, and I expect next cycle will be such where people are going to have to be creative. What are they really trying to do ultimately? They're trying to deliver the most value to their teammates. That's what people go into benefits to do. They want to deliver real value. They don't just want to cut costs. To Steve's point, these are ways to do it, whether it's promoting stuff that already exists or or fiddling around with it, there's real value here. And that's what people look into.
spk06: Great. And what does your guidance imply in terms of new ads for the fourth quarter?
spk02: I don't think we literally give sales guidance, but I guess what I would say is, as Tyson commented earlier, if you look at last year, We ended up selling in the full year, I want to say, a little over 900,000 accounts. And if you look at each quarter this year, while the new ads have slowed down, as you might expect, as the labor market slowed down a little bit, they've been on a really good pace. So it's probably similar to the message I would have given you on this topic at this point last year, which is, Do I think that we're going to blow through a million accounts? No, I don't. There's just not enough accounts out there, but we should have a very healthy year, certainly as healthy as last year.
spk19: Perfect. Thank you.
spk02: Thanks, Mark.
spk12: Our next question comes from Alan Lutz with Bank of America. Please go ahead.
spk11: Hey, everyone. Thanks for taking the question. Tyson, I guess on the OPEC side, technology and development as a percent of revenue has kind of steadily ramped since fiscal 15. I think it was around 12% of revenue then, and then even pre-COVID it was about 15%, and now it's at 21%. I guess just a level set, what exactly are the increases in tech and development being spent on? And then I guess, is there any chance, or I guess what's the timing around when we can see some operating leverage from that part of the business? Thanks.
spk17: Yeah, that's a good question. Thanks for asking it. You were exactly right on the numbers going up like that. It has to do with mainly the acquisitions, right? So you think about wage and then further Those play a big part in that, the amortization of the capitalized development that's in there, the security build-up that we've done. We have built a very good security team over the course of my tenure here and spent quite a few dollars putting that in place, and I think it's as good a selling tool as anything. So that's in there. So I don't think You know, there's no chance now that it goes back to where it was before, and I don't think that'd be the right thing to do for the business. I do think it's sort of leveling off. The other thing I would say in there, too, is that a lot of it has to do with Stockholm, you know, coming through and the talent grab that we need to make in that particular area. And so you see that playing into that as well. Of course, that's getting back down to the even or margin side, so you don't see the impact of it there. But a lot of that increase will be you know, in that area. And then really, when you think about other things that are in there, there's not any large investment in there necessarily. There's just the merit and the associated costs of the folks that are in there and then how much we end up capitalizing relative to, you know, what we're building. I don't know, John, if there's anything else you want to add to this strategy?
spk02: I mean, the only other – look, I think big picture, I mean, it's – it's kind of gotten about as high as it's going to get, is the way I might put it, at, you know, low 20s percent of revenue. It's kind of funny. I mean, when we were at 15, as I recall, Alan, one of your predecessors was like, it doesn't sound like enough for a growth company. And, you know, the way I kind of look at it is I do think when you sort of go apples to apples, we have increased spend in this area. And the sources of increased spend, I think, are ultimately refold. First is technology, I'm sorry, is security, as Tyson mentioned. I think the second is the fact that we are actually investing more to innovate around the business. And you've seen that in what the business has done over the course of time. in any number of areas and will continue to do. We talked about some earlier in this call. And then the last thing that it's worth mentioning is that in practice, in the near term anyway, the conversion to cloud on the IT side, as you're doing it, it does hurt you a little bit. Now over time, that works itself out, and that should be a tailwind. But I think that plus having kind of now getting through the amortization of acquisition-related technology spend and all that. I think you're going to see this number start to come down as a percentage of total revenue over time without, like, percolating efforts on our part.
spk11: Okay, that's helpful. Thanks, John. And then there was a $9 million sequential benefit in custodial revenue. I think we talked about this last quarter. There's a couple different buckets that are driving that, enhanced yields and then the SOFR LIBOR increases, and then you're also guiding for a 5% quarter-over-quarter increase in yield from 2% to 2.1%. Obviously, some of that's going to be from the repricing, but I guess as we think about the benefits that you saw over the course of fiscal 23, a lot of cash being deployed How should we think about the step-ups quarter over quarter in fiscal 24? Is that going to be more of a kind of flattish year where the yield you get exiting the fiscal fourth quarter of this year is going to be more or less the yield that you're going to have over the course of the year? Is there anything else we should be thinking about modeling for that? Thanks.
spk17: Well, just to make sure, the guide for the year is 190 basis points, so I just want to make sure that's clear. I know we put a lot of yield numbers out there, so we're just all kind of getting, level set on those. And then I think, you know, when you think about Q4, right, it's a partial quarter, and you have those placements, and you have the roll-off of the ladder coming through there, Alan. So, you know, you do get a little bit of upside relative to those new placements on the old contracts that were there, because we're going to place at higher rates, and we're going to place at higher enhanced rates as well. So it would, you know, you'll have some increase there, but again, it's built into the guide that I gave already on that one.
spk02: I think what Alan was asking is really about with regard to fiscal 20, fiscal 23, we had this, you know, relative to where we started the year, we had this pretty big step up quarter over quarter in yield, in yield on HSA cash. And I think Alan was sort of asking about how to think about that two 20, how to quarterize the two 25.
spk17: I see. Yeah. I mean, the one thing that won't be there as well, whether the Fed continues to raise rates, it will be on less variable HSA caps in there. So that was one of the things that you saw continually kind of pushing that rate quarter on quarter. So that would, and back to your question, Alan, it would temper that because it wouldn't be as big a base number on that Fed yield improvement if that were to occur.
spk02: But it's probably safe to say without stepping into your territory, Tyson, that there is still some polarization, just less dramatic than this year. And that's going to be reflected in the fact that our view is that over time, under any mainstream economic scenario, these yields are going to continue to go up because we're still going to be replacing these contracts that came in during the pandemic and all that kind of stuff. So there is going to be some level of tilt. from the first quarter to fourth quarter, this won't be as dramatic as it was this year.
spk19: I'll have to . Thanks, Alan. Got it. Thank you.
spk12: Our next question comes from Sandy Draper with Guggenheim. Please go ahead.
spk03: Sandy. Hey, how are you? Not a lot left to ask here, but maybe just a balance sheet question. On the other side of the interstate environment, you mentioned Tyson, the variable rate debt. Could we be thinking about, it looks like you're on track to do, I don't know, say round numbers, $100 million in free cash flow this year. That would likely grow next year. Is the primary focus going to be on paying down the debt, and how should we be thinking about that free cash flow and how to bring that debt down? Thanks.
spk17: Yeah, I mean, we're going to generate a lot of cash flow over the next couple of years, right? So when you think about how that works, it is going to be one of the top items that I'll be thinking about to pay down that debt relative to, obviously, portfolio acquisition opportunities as they come to market. But again, those may be a little slower just given the negotiations that occur over a terminal value and things like that. to make some pay down on that TLA so we can kind of get rid of that headwind. So it's there, and that cash balance is starting to raise to a place where we may make that. From a perspective, just get a little bit in the weeds, and from a terms perspective, we get to deduct about $350 million that kind of caps out their cash to do the terms on our debt, if that makes sense. It's in our queue if it doesn't. So I won't get too close to that before we start making a pay down or an acquisition.
spk19: Got it. Thanks so much. That was my question. Thanks, Andy.
spk12: Our next question comes from Sean Dodge with RBC Capital Markets. Please go ahead.
spk19: Hey, Sean.
spk14: Hey, good afternoon. This is Thomas Keller. I'm for Sean. Thanks for taking the question. So first one, and I know there's nothing factored into fiscal 24 guidance, and you just touched on a little bit, but As you all think about HSA account growth over the next year or two, do you expect M&A could still be a meaningful driver, or are most of the bigger near-term opportunities for consolidation kind of off the table at this point?
spk02: No, I think that M&A still has a role to play, and we continue to have very active discussions. Obviously, as we talked about earlier in the year, this is an environment where we continue We want to be disciplined about what we do, and it can be harder for buyer and seller to come to an agreement. But I think the counterweight to that is that sellers can look at where they stand on the lead tables and understand, apropos of the investment discussion a few questions ago, whether it's CapEx or OpEx, they also understand what they're putting into the business versus what we are and what other we'd be more likely to be utilizing cash on acquisition opportunities that have high returns for you all and the shareholders. And certainly if we can, that's what we want to do. All right.
spk14: That's helpful. Thanks. And then a question on the investment accounts. Have you seen any changes in adoption or interest there, given you've got other options like the enhanced field product? I guess maybe versus your internal expectations or Or thinking about it a different way, are you making any more of an effort around education on the merits of, you know, one versus the other?
spk02: We don't. We're very careful not to give guidance to our members or advice to our members with regard to should I be in investments, should I be in cash, and, you know, that kind of thing. So we do give advice with regard to through our registered investments. Generally, we will do a lot in terms of education to help people understand the long-term value of being in investments. I guess my view is that if I look at HSA behavior relative to the behavior of other types of investment accounts that are out there during this year's period, at health equity he's actually grown by a little bit on a year-over-year basis notwithstanding the fact that both that that you know within our industry more broadly certainly that has not been the case per debonair and then if you look at you'll get much more broadly at you know traders or pay balances I think it's fair to say that those folks would be very happy with their with flat year-over-year We're slightly up year-over-year account balances. So I'm pretty pleased with the predictability of behavior that we've seen around the products. Thanks, Thomas.
spk19: All right. Thanks.
spk12: Our next question comes from David Larson with BTIG. Please go ahead.
spk16: Hi.
spk20: Hey, how are you? Can you please talk about health card revenue and also commuter revenue and How is that trending this quarter relative to expectations? And what's taking the guidance? And I think at sort of the peak headwind year, there was like a $30 million headwind for those two businesses. Just any color around how that's trending relative to your expectations. Thanks a lot.
spk17: I mean, I think overall they're within the range of how I think about forecasting them. They're definitely not exceeding expectations. In the event that stuff is kind of slowly coming back through, and I'm not going to really ever think about getting ahead of that again. I think it kind of is what it is. It's becoming a very small part of the business when you think about low single-digit contributions, even though it is at high margin from a perspective of the product. And from a card perspective, you know, we were talking about this a little earlier in the Q&A, probably a little light in Q3, but again, within the range of reasonableness. You're talking about a few hundred thousand dollars a month where it's just kind of a little bit below expectations, so I don't know what to make of that. It's hard to forecast anyway because it's transactional, and so I think it was, again, in the realm of reasonableness, and Q4 is interesting because that's the use of the loser quarter, and so you kind of see what people do, and then that's the heaviest quarter of spend, and And I guess the last thing I'd say is, I think, and John already mentioned this, because, again, we're on the FSA side versus the HSA side. The HSA side seems to be very steady. People use that in a much more steady way because it's a longer-term account. You get the volatility on the FSA side when you kind of get the reactionary things to whether it be legislation or use it or lose it.
spk20: Thanks very much. And then in terms of wage synergies, I think the guidance had called for $80 million in annual synergies. Where are you at that $80 million? And how much sort of incremental benefit are you expecting for next year, fiscal 24?
spk17: I mean, we've done the work. We've hit the number. We reported that $80 million. So, you know, as far as like the contribution, it's in there and it will run right through. So that $80 million is there. What I would say, too, though, is when you think about revenue, there's not a revenue synergy as part of the $80 million. So when you think about the bundled sales approach and the fact that we're selling HSAs up in the $900,000 range over the last years here versus down in the $700,000 range, there's a macro element to that. There's also the strategy change that came from wage. So that's a benefit of that, along with other things that just we get from scale, whether it be better rates on interchange, whether it be other things that we can get relative to scale, including, I think, the enhanced rate partnerships and having enough cash to really go out and get multiple partners in that area too. So there's a lot of synergies that aren't quantified there, but as far as the aid, we're done with that. And we're also done with the spend as well relative to the wage deal. And you see the further spend, which was a much smaller number, working its way through, but decreasing And so, therefore, the cash that comes from that, the business generates more cash thanks to the decreasing merger and integration spend.
spk20: Okay. As a unified product, your go-to-market strategy, I think, is probably more effective. It's generating more sales. That's great. And then just my last question, in terms of, like, the overall interest rate environment, I think the federal funds rate is at about 3.8% right now. If you look at the Fed's projections, they were calling for – around 4.8% by the end of, like, calendar 23. That's 100 basis points up. We're at 6% core inflation. They want to get it to 2. So my view is interest rates might go up well above 100 basis points next year. Any thoughts around that, just broadly speaking? And then let's say we do end up at around 5% as the federal funds rate. Does that mean your yield is going to be 500 basis points at some point in time? Thanks.
spk17: Well, you're getting into fiscal 25, guys. You know, the consistent message there is, you know, as you said before on this call, is replacing those contracts that were negotiated in that zero interest rate environment with whatever the rates are at that time. So if they're higher at that time, not this January but next, that's going to be great for the business. high for 26, 27, 28. Eventually, you've got to do the math and things. You're not necessarily wrong. It's just math, right? But it works its way through the ladder both ways, up and down. So it's a reasonable thing to talk about. It's just not really there.
spk20: Okay, appreciate it. Thank you.
spk19: Thanks, David.
spk12: This concludes our question and answer session. I'd like to turn the conference back over to John Kessler for any closing remarks.
spk02: Well, we managed to do that in not quite under an hour, but we're working on it. Thanks all, and happy holidays to everyone, and look forward to talking to a bunch of you in the next few days. And if we don't, then again, please, everyone, wish you a safe and hopefully family-oriented time at the end of December. Enjoy. Thank you.
spk12: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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