This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk19: Hello and welcome to the Health Equity Third Quarter 2024 Earnings 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 from the queue, please press star then two. Please note this event is being recorded. I would now like to turn the call over to Richard Putnam.
spk28: Thanks, MJ.
spk29: Hello, everyone, and welcome to Health Equity's third quarter of fiscal year 2024 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 Nealman, vice chair and founder of the company, and James Lucania, executive vice president and CFO. Hello. Before I turn the call over to John, I have two important reminders. First, a press release announcing the financial results for our third 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 the comparable GAAP measures, and a recording of this webcast can be found on our investor relations website, which is ir.healthequity.com.
spk00: Second,
spk29: Our comments and responses to your questions today reflect management's view as of today, December 5th, 2023, and will contain forward-looking statements as defined by the SEC, including predictions, expectations, estimates, or other information that might be considered forward-looking. There are many important factors relating to our business which could affect the forward-looking statements made today. These forward-looking statements are subject to risk and uncertainties that may cause our actual results to differ materially from statements made here today. We caution against placing undue reliance on these forward-looking statements. We also encourage you to review the discussion of these factors and other risks that may affect our future results or the market price of our stock, as detailed 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.
spk17: Now, over to John. Thank you, Richard.
spk20: Your emphasis on the word caution made me feel like you know more than you let on, but I know you know a lot. So, hello, everyone, and Thank you for joining us, and happy holidays. I will discuss performance against Q3 key metrics and management's view of current conditions. Richard doesn't know anything more than he's letting on, by the way. Jim will detail Q3 financial results, and then he will provide our raised guidance for fiscal 24 and an initial outlook for fiscal 25. And Steve, of course, is here for Q&A. In Q3, the team delivered double-digit year-over-year growth in revenue, which was plus 15%. Adjusted EBITDA grew double that at 30%. HSA assets grew 12% year-over-year, and HSA members, again, also at fiscal quarter end, grew 8%. Total accounts grew 5%. Health equity ended Q3 with 8.3 million HSA members, 22.6 billion in HSA assets, and 15.3 million total accounts. Turning to sales, the team added 163,000 new HSA members in the third quarter, which narrowed the year-on-year gap relative to last year to 4% as we begin to lap the tour job growth and quit rates from Q1 and Q2. New logo growth, driven by a strong performance of our team, as well as our expanded network partner footprint, helped HSA growth in Q3 just as it has throughout fiscal 24 to date. HSA assets ended Q3 at $2.4 billion higher than a year ago, reflecting not only account but also balance growth. Sequentially, invested HSA assets declined during the fiscal quarter by $0.6 billion due to negative market action and Total assets therefore declined by the same amount. Members continue to invest their HSA balances, however, partially offsetting market declines. Year over year, 12% more of our HSA members became investors, helping to drive up invested assets by 21%. In fact, invested assets now account for nearly 40% of HSA assets. As you know, we believe that our members, our mission, and our long-term financial performance all benefit from the continued growth of investing in HSAs. We also continue to see more members choose enhanced rates for their HSA cash, leading to a higher or longer custodial yield and, we believe, less cyclicality. While custodial fee growth drove Q3 revenue and margin performance, the team also delivered modest progress on the service line. Service costs actually declined year over year, and sequentially, despite higher volumes, of course, to help drive modest margin expansion. Interchange revenue grew strongly year over year and on a sequential basis and is now following its pre-COVID seasonal pattern as we expected, with strength in Q1 followed by softness in Q2 and especially in Q3. We expect sequential strengthening again in Q4. Our new CFO will detail our raised outlook for fiscal 24 and preview fiscal 25 in addition to providing more detail on Q3 results. You know, double-digit revenue growth and margin expansion is a pretty good first act. However, Jim would be quick to point out that health equity's current trajectory was years in the making. The team raised the trajectory of HSA growth by adding CDB capabilities at scale through WageWorks. It grew the value of HSA by pioneering affordable and accessible HSA investing and creating the enhanced rates program for HSA cash. It increased market responsiveness and resiliency by integrating with network, client, and ecosystem partners at every turn. And it enabled accretive allocation of your capital by uncovering HSA portfolio acquisitions, including Benefit Wallet, which upon completion will be our largest such transaction ever. Today, the team is innovating the value drivers of tomorrow, applying cloud, API, data science, and yes, AI technology to health equity's mission to save and improve lives by empowering healthcare consumers. With that, I will turn it over to Jim.
spk22: Jim. Thank you, John. First, let me say it's been a pleasure to join the health equity team and have the opportunity to meet many of our investors over the past three months. The results we're reporting today are directly linked to the commitment our team makes every day to deliver purple service to our clients and members. I'll highlight our third quarter gap and non-gap financial results. As always, we provide a reconciliation of gap measures to non-gap measures in today's press release. Third quarter revenue increased 15% year over year. Service revenue was $107.5 million, down 1% year over year. Custodial revenue grew 43% to $106.6 million in the third quarter. The annualized interest rate on HSA cash was 258 basis points for the quarter. Interchange revenue grew 7% to $35.1 million. Gross profit as a percentage of revenue was 64% in the third quarter this year, up from 59% in the third quarter last year. Net income for the third quarter was $14.7 million, or 17 cents per share, on a GAAP EPS basis. Our non-GAAP net income was $52.2 million, or 60 cents per share for the third quarter, up versus 38 cents per share last year. While higher interest rates increased custodial yields, and generated additional interest income, they also increased the rate of interest we pay on the remaining $287 million term loan A to approximately 6.7%. Adjusted EBITDA for the quarter was $95.6 million, and adjusted EBITDA as a percentage of revenue was 38%, more than 440 basis point improvement over the same quarter last year. For the first nine months of fiscal 24, Revenue was $737.2 million, up 17% compared to the first nine months of last year. Gap net income was $29.3 million, or $0.34 per diluted share. Non-gap net income was $140.5 million, or $1.62 per diluted share, up 69% compared to the same period last year. An adjusted EBITDA was $270.3 million, up 36% from the prior year, resulting in adjusted EBITDA as a percentage of revenue of 37% for the first nine months of this fiscal year. Turning to the balance sheet, as of October 31st, 2023, cash on hand was $334 million. boosted by $57 million of cash flow generated from operations in Q3 and $166 million year-to-date. The company had $874 million of debt outstanding net of issuance costs. We continue to have a $1 billion undrawn line of credit available, and we anticipate using both cash and drawing on the line of credit in fiscal 2025 in connection with the closing of the benefit wallet HSA acquisitions. These strong results combined with expectations for our Q4 busy season allow us to raise fiscal 2024 guidance as follows. Revenue in a range between $985 and $995 million. Gap net income in a range of $34 to $39 million, or $0.39 to $0.45 per share. We expect non-gap net income to be between $181 and $188 million, resulting in non-gap diluted net income between $2.08 and $2.16 per share, based upon an estimated 87 million shares outstanding for the year. We expect adjusted EBITDA to be between $350 and $360 million. Our fiscal 2024 revenue increase is primarily based on revised expectations for the average yield on HSA cash to approximately 245 basis points for fiscal 24. As a reminder, we base custodial yield assumptions embedded in guidance on an analysis of forward-looking market indicators, such as the secured overnight financing rate, mid-duration treasury forward curves, and the Fed funds futures. These are, of course, subject to change. Our guidance also reflects the expectation of higher average interest rates on health equities variable rate debt versus last year, primarily offset by the reduced amount of variable rate debt upstandings. We assume a 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 expect positive GAAP net income this year. As we have discussed, moving the positive GAAP net income impacts our GAAP tax rate strangely this year. Discrete tax items may also impact the calculated tax rate on a low level of pre-tax income. Based on our current full-year guidance, we expect a GAAP tax rate for fiscal 24 slightly below 40%. As we have done in recent reporting periods, our full fiscal 2024 guidance includes a reconciliation of GAAP to the non-GAAP metrics provided in the earnings release, and a definition of all such items is included at the end of the earnings release. In addition, while the amortization of acquired intangible assets is being excluded from non-GAAP net income, the revenue generated from those acquired intangible assets is included. We're also providing the following initial guidance for fiscal year 2025. We expect revenue to be between $1.14 and $1.16 billion. We expect margins will expand with adjusted EBITDA growing to approximately 38% to 39% of revenue in fiscal 2025. This initial guidance is based on an estimated average HSA cash yield of about 3%, based on our outlook of interest rate conditions, current forward yields for next year, and the anticipated migration of the benefit wallet HSAs in fiscal 2025. We expect benefit wallet ramp-up costs will in effect extend our busy season further into the new fiscal year than usual, with net positive impacts expected to begin by Q2. A reconciliation of our adjusted EBITDA outlook for the fiscal year ending January 31, 2025 to net income, its most directly comparable gap measure, is not included because our net income outlook for this future period is not available without unreasonable efforts as we're unable to predict the ultimate outcome of certain significant items excluded from this non-GAP measure, such as depreciation and amortization, stock-based compensation expense, and income tax provision or benefits. Before we launch into Q&A, let me give another plug for our investor day scheduled for February 22nd at our offices in Draper, Utah. We expect to share information about HealthEquity's multi-year strategic initiatives to deliver remarkable experience, deepen partner relationships, and drive health and financial outcomes, and the impact we anticipate these initiatives may have on our business model and financial performance over the next several years. You will see product innovations being shared with our clients and partners, as well as a deep dive into our plans to accelerate the transition to enhance rates. We're nearing capacity, so if you want to be there, and you do want to be there, you will need to register quickly. Please see our IR website or contact Richard. With that, we know you have a number of questions, so let's go right to our operator to kick off Q&A.
spk19: Thank you. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. Our first question today comes from Greg Peters with Raymond James. Please go ahead.
spk25: Well, good afternoon, John, Steve, Jim, and Richard. Hello. I'll kick off the first question with the state of the market as it relates to M&A. I know you will be working to close BenefitWallet in the first half of next year, but another large competitor of yours, maybe more, have commented on the possibility of monetizing their HSA asset through a sale. So can you talk about what your appetite looks like for additional M&A and maybe just how you view your market players behaving in this environment?
spk20: Yeah, I mean, I think, first of all, thank you, Greg, for the question. I think the first point is that I think this reflects a trend that has been going on for a while, which is continued kind of, for lack of a better term, consolidation of the market around a couple of strong-scale players. And we're really pleased to be at the head of that trend. group at this point and have worked very hard for it over time. And one of the things that we've done over this period is really kind of honed our thinking about how we deploy shareholders' capital when we look at competitive transactions. And so we're in a very fortunate position that to the extent that something else is out there. And to the extent that, you know, one is that you should feel confident that we're going to be able to evaluate it effectively without, you know, kind of having to resort to, you know, investment banker magic. And that secondly, that, and I think benefit will demonstrate this, that we're going to shape transactions in a way that is a win for the seller, but also a win for our shareholders in terms of the timing of accretion, and all that kind of thing. So I think that puts us in a good position if transactions kind of start to happen. I think secondly, we'll obviously talk about this a little more at the Investor Day, but I think external models suggest that and certainly our forward guidance envisions that the company will continue to generate significant cash flow from operations and free cash flow generally, and that those numbers will only grow. So, you know, as I've said before, this is an ideal place for us to deploy capital in ways that generate real return to earnings. And ultimately, we believe to our shareholders. So we'd be very interested in that. That having been said, I think we also benefit from the fact that we've been beating these bushes for a very long time, and we also know sometimes why something comes to market, where our competitors might be more challenged, and those things are going to be reflected in our view evaluations. So, That's, I guess, my way of saying, Greg, that if you see something happen, you know, I don't know, mid-next year, late next year, and to be clear, I have no idea, genuinely. And it's not with us. It's not going to be because we didn't take a look at it. It's going to be because we carefully evaluated the price and decided not to do that, and we've done that in the past as well. So we're happy to hear those kind of rumors. We think they present great opportunities for our shareholders. We're also going to evaluate them carefully.
spk25: That makes sense. I have a follow-up question, assuming that Richard, the enforcer, will permit it.
spk20: Can I ask you a favor? I'll be the... Let's do one, but we did get more murmurings of challenges, and it's like Mr. Bigglesworth. We don't want you to be angry, so let's do one. We'll go from there.
spk25: One follow-up?
spk20: Yeah.
spk25: Perfect. Just... You made a comment in your opening remarks about how the enhanced yield product will give you higher for longer custodial yield. One of the popular questions that comes inbound is how your custodial yield might perform if interest rates were to start to go down. So maybe you can help us explain what you meant by that comment. That's my last question.
spk21: Let me first, well, actually, Jim, why don't you take this one?
spk22: Yeah, yeah, sure, I can. Yeah, so the, I mean, obviously, the initial outlook that we provided is based on forward-looking expectations of rates, and the market has for some time expected rates will come down next year, and that's reflected in our outlook, and we will have a small headwind We expect to have a small headwind on our client-held funds, right, the deposits that are really held short-term in overnight cash. So that's a small headwind to our yield next year, but we're still seeing the reinvestment rates at significantly higher rates than the cash is maturing at. So we are growing average HSA yields in a declining –
spk17: interest rate, short-term interest rate environment.
spk16: Okay, but in your comment, you said the enhanced yield gives it higher for longer.
spk25: I'm sorry. I've expired my two questions.
spk20: Thanks. I'm guessing there might be another one about this topic, so we're happy to go into one. Who's next?
spk19: The next question is from Stan Bernstein with Wells Fargo. Please go ahead.
spk09: Hi, thanks for taking my questions. Maybe first on the preliminary. Hi. On the preliminary guidance, I guess first, how should we think about the benefit wallet assets that are flowing in? Can you give us a sense of the timing of when these tranches are going to come in? To what extent are we getting the benefit through the year? And associated with that, Maybe I'll layer a couple more questions in here. Do you have to pay any fees on those assets moving into your custodial accounts? Let's start there.
spk20: Yeah, I think I can take this one. So let me start with the second part of your question, Stan. As you recall, in prior transactions, we've had a component where there's a seller, a third-party custodian that we have to pay. We had that in the WageWorks transaction. We have that here. That's based into, technically the way it works in this case is it's the seller paying the fees and we have agreed as part of, and I think we disclosed this at the time the agreement was signed, we've agreed to cover, I believe, someone correct me if I'm wrong, $20 million of such fees within the purchase price. So that doesn't impact our projection of go-forward income or the income statement in any way. It's just a purchase price accounting issue. And then with regard to the first part of your question, the way to think about this, I think, is that, and Jim mentioned this briefly in his opening remarks, is that we will see incremental service expense effectively our busy season extending into the first bit of the fiscal year, as we prepare to bring on these accounts, it would be silly to fully ramp down and then ramp back up again. So there'll be some, and even if we were doing that, we would still see incremental costs. So you'll see some incremental service costs. And then in Q2, we should start to kind of net out to a positive here as we begin to onboard these accounts. our guidance kind of reflects that idea that these transitions will occur kind of in that timeframe and by the second half of the year we'll be at run rate. And as we've discussed elsewhere, this kind of accretes very quickly. So if that's helpful for you, we can't, I would say there's some uncertainty here, as there often is, but that's our current expectation.
spk09: That's helpful. Thank you. Maybe just a quick one on services gross margin. Clearly, you're making some progress here. Can you maybe share any updates on the adoption of your text-based communications with your members and whether or not you're recognizing some tangible improvements on the gross margin side there?
spk20: Yeah. Well, Jim talked about the progress on gross margin generally. I think, obviously, if you look at service expense and the like, the ability to kind of be in a good spot here relative to volume growth speaks to the point that you're making, particularly given that we're also fighting things like wage growth that are headwinds in this area. And so, yeah, I commented elsewhere that we've made, we look at this month over month and what we're really trying to do is ultimately it's, it's not just, it's in part the, the, the move from voice to chat, but it's also ultimately the move from live to automated in areas where members really get value out of that. And there are clearly a lot of those. And so we continue to see kind of, I would just say quarter over quarter progress. It's not, and we've never suggested it was a magic bullet, but the ultimate opportunity to take significant costs out of service delivery while delivering actually a better experience for members through digitization. This is, as I've said elsewhere, is a no-brainer in terms of, it's sort of ironic to say this, in terms of the applications for generative alternative AI. It just, you know, damn, this stuff really works. And so we think that that will continue and we think that what we do is actually an excellent application for it because precisely because it's not, you know, it's always as simple, and people's questions aren't always as, you know, formed in exactly the same way, and yet you want to be able to generate the right answers. Thanks, Dan.
spk19: Thank you. The next question is from Alan Lutz with Bank of America. Please go ahead.
spk10: Hey, Alan. Thanks for taking the questions, and welcome, Jim. A couple on the financial side. So I just want to... Ask on the 3% custodial yield guide for next year, how much of those contracts have already been set? And then one follow-up related to the financials, is benefit wallet fully incorporated into the fiscal 25 guide? And then I have a follow-up. That sounds like three. That's three.
spk22: Yeah, so as John said, our expectation about both the ramp-up cost, the transition cost, migration cost, and then, of course, the benefit of having the accounts on our platform are built in to the 2025 guide, as are those assets will be invested at market rates, which will obviously pull up the average rate earned on HSA yield. So yes, benefit wallet is a contributor to revenue and to the higher yield that we're going to be guiding to here.
spk20: And then just as to the first part of your question about placements, the math is a little different with enhanced rates now where we can do placements throughout the year, so it's a little less relevant, but a way to think about it is that we do placements mostly when money moves in terms of when rates are cut. about a third of that happens in the, if you sort of think about that year-end bulk, about a third of it's in the fiscal Q4, or calendar Q4, and then two-thirds is kind of in that January period. But I would caution that, I just would caution on that last point, enhanced rates does have a benefit that allows us to draw that out a little bit, and so Over time, what you'll have to get used to is, and I think this will be good, is that it's not going to be sitting and waiting for what the rate is on a given day. It's going to matter as much for those kinds of placements.
spk15: Thank you. The next question comes from David Larson with BTIG.
spk19: Please go ahead.
spk06: Hi. Congratulations on an excellent quarter. Can you maybe just talk a little bit about expectations for yield longer term? Obviously, I wouldn't ask for guidance for fiscal 26, but since it takes three years to recontract your book of business, let's say rates hold steady or decline slightly next year, maybe they decline slightly in fiscal 26, could your yield still go up, which would obviously benefit custodial in fiscal 26?
spk22: Jim, you want to hit this one? Simple answer is yes. Obviously, it depends how far rates decline. But yeah, I think you said if rates remain stable, then yes, we'd expect the average rate to continue. There are strong tailwinds in that number.
spk20: it's the key issue is that the, one of the things that we really do get benefit of, if you think about it, um, I appreciate your point about three years, but, but think about like the duration contracts. Um, you think about what we're, we're going to be replacing next year. Those duration contracts next year will be the first ones that we're replacing, right. That are pandemic era. So the stuff that's being repriced is going to be repriced in, in, you know, very favorably. And, um, Beyond that, if I take current market projections about where rates will be in a year or what have you, as sort of consistent with your question, we will still be placing new money at rates well above our current And so those will continue to be, you know, I think pretty significant tailwinds for yield for quite some time, actually, you know, again, without wanting to give particular guidance. I mean, those are the key factors and it's what you can replace money at relative to what you had it at before and what you're placing new money at. And both of those appear to be tailwinds for quite a while under, you know, any current reasonable scenario over the course of the next several years.
spk06: Okay, great. And I think Richard will allow me one more maybe. So it was nice to see the interchange revenue up, I think, 7% year over year. For service revenue, I think it was down maybe 1% year-over-year, but I think there's some unusual things causing that. When should we expect to see growth in service revenue sort of return to a more normalized rate? What is the driver of that, and what would you expect sort of that longer-term normalized service revenue growth rate to be? Thanks very much. Want to hit that one, Jim?
spk22: Yeah, sure. I can take that one. Yeah. So I think, yeah, you really hit right on the story for Q3. We've effectively held serve on that line with revenue slightly down, cost slightly down, the margin slightly up. But there's a lot of moving parts and stories within that line. within those headline numbers. So you sort of look at it, and we do look at it by product, and you see a price volume mix story occurring there where price has been a headwind, especially in RA. As buyers look at this as a bundle, really, they understand we're making a much higher revenue on the custodial cash and the HSA cash. They understand we're making good margin on the interchange, and this is the release valve on price. So, we're seeing a little bit of price per unit price headwind. We see the impact of the mix shift, especially towards HSA. As we're growing HSA significantly higher, that's always been the lowest fixed dollar fee product as it's got the highest percentage of interchange and custodial revenue attached to it. So as our business mix towards that, we're going to see that pressure on the revenue line and that margin line. And you can call that sort of a half and half impact price and mix and then being offset by our much higher volumes. So negative price, negative mix, positive volume, that's out to just about a million dollar delta on the revenue line.
spk12: Thanks, David.
spk19: The next question is from Ann Samuel with JP Morgan.
spk27: Please go ahead. Hi, guys. Congrats on the quarter, and thanks for the question. You know, in the past, you've kind of talked about a gradual increase for your deposits going into the enhanced rates product, but, you know, with Benefit Wallet, you're going to see kind of a big jump up in that, you know, that mix. You know, are you where you want to be now, or should we expect that to continue to, you know, kind of increase as a percentage of the mix over time? You know, where are you hoping to get with that?
spk20: You should expect it to increase as a percentage of the mix over time, and if you're willing to make the step out to Salt Lake City or listen in, I think we'll talk more about that so people can get a clear view of it over time. But we're extremely pleased with a couple of aspects of this program. One is that... is that on a voluntary basis, the consumer adoption has been great. I think consumer acceptance of what we're trying to do has been great. I feel like employers, those who pay attention to this, understand that the fact that we've done this has really kept us from having to impose other costs on them and also see us reinvesting in the business. I'm extremely pleased with I just don't know how to say it any other way, with the work that the team has done to educate the best possible partners we can have for this product. We went into this with the biggest question in our mind was actually what's going to be the receptivity within what is appropriately a very conservative market on the insurance side to a product that has a lot of great attributes for them, but they just haven't had them before. And the receptivity has been great. It's been great among very high-quality names. And the stable there continues to grow. And so we're absolutely looking at options to accelerate, if anything, the shift into this product. And we'll talk a little more about that, I'm guessing, at the Investor Day and its impact in the out years.
spk27: That's really helpful, then. And I guess as we kind of think about, you know, as you get bigger and bigger with this product, is it still right to think of it as kind of a 50 to 75 basis point premium to your kind of traditional yield, or can that change over time as well?
spk20: I think that's still probably right.
spk21: I mean, it's – I think that's still probably right. Thanks, Dan.
spk19: Thanks, Dan. The next question comes from George Hill with Deutsche Bank. Please go ahead.
spk02: Hey, good evening, guys. Good evening. And just a couple of housekeeping questions, actually, for me. I guess, number one, John or Jim, could you guys talk about the expected EBITDA contribution from Benefit Wallet in fiscal 25? And my follow-up is I know you guys have some lumpiness of, uh, cash rolling off to be redeployed as we look out over the next 12 to 18 months. Can you just kind of remind us on the, on the big pieces that kind of, that kind of come off being committed and get recommitted, um, and so we can kind of fine tune our, our models around the waterfall. Thanks for that.
spk20: Thanks. Why don't I, you want me to take the first half and you take the second half, Jim? Sure.
spk11: Yep. Sure.
spk20: Okay. Um, so, uh, A way to think about benefit wallet is that, you know, as I suggested earlier, you know, we're going to get a little bit more than half a year impact. Maybe you could say, I don't know, maybe say two-thirds of a year impact. I don't know. Somewhere around there this year. And this product, you know, this transaction, like prior transactions we've done, is going to be highly accretive. We were already anticipating that we would be delivering a nice implied boost in EBITDA margins, and I think this has just helped us accelerate, for lack of a better term, where we ultimately felt we would get to as we have accounts mature and so forth. you know, the way I think about the first question is, and I would, you know, encourage someone to do their own modeling, but I think, you know, I remember, George, you asking me several years back, you know, whether the company could return at some point, and I think you were being a little bit, what's the word I want? You were sort of poking me a little bit, saying, you know, can you guys return to EBITDA margins with a forehandle? We're offering guidance right now for next year between 38 39 and um so um this has sort of accelerated some of that process and and uh that seems like a good thing uh jim on the second half you want to take that one which was about i think about the timing of of uh of asset redeployment yeah yeah yeah exactly reinvestments and that yeah you're exactly right like the um there's there's sort of a block of of wage um
spk22: bumps in assets that are going to be maturing actually not so much in next fiscal year. We've got a relatively smaller block of assets maturing Q4 of this year and throughout next fiscal year, and it will be the following two years where some of those lumpier blocks are going to be maturing. Being reinvested is a better word to say.
spk20: Thanks, George. A way to think about that is since we deployed the original wage assets in, I'm going to say, calendar 21, no, calendar 20, and the kind of core piece of that is five-year, right? You'll see a lot of that rollover in the middle of calendar 25. There's a little of it this year, but you get the idea.
spk17: And we'll roll over well because we all know where we were in 2020. Sorry.
spk18: The next question comes from Mark Markun with Baird. Please go ahead.
spk07: Hey, good afternoon, and thanks for taking my question. And let me add my congratulations. I'm just wondering if you can talk a little bit about, you know, you had good new logo sales. I'm wondering if you can talk a little bit more about what you're seeing on the enterprise side, just in terms of both from a competitive perspective, but also in terms of the desire to shift, you know, part of the employee population to, you know, HDHPs, you know, particularly in light of the accelerating, you know, healthcare costs that are coming through. And then I've got a follow-up.
spk08: Do you want to hit this one? Sure. Happy to. Hey, Mark, how are you? I expect you'll be out in February. Absolutely. Because we did get our first big snowstorm this weekend. Anyway, so kind of in order, yeah, I mean, we talked about in the comments that we're seeing some good progress on bringing on these new enterprise logos. And this has been a lot of work, put a lot of time into it. We've not only refined our marketing message and brought on some great sales team members that are hustling there, but also I think our product team Sweet is continuing to evolve to take care of their needs. I mean, we're doing some really nice things there. So I think the bottom line is we're pleased with the progress we've made in the new logos. Now, I'm continually amazed. And maybe it's just because, as you know, Mark, every year, I'll tell you a little fact that this is from the Kaiser study. The average high deductible plan that is HSA qualified is in the country is about $4,800 for a family plan. And the average non-HSA deductible, let's say for a PPO plan, is about $2,900. So as those numbers keep getting closer, it really doesn't make a heck of a lot of sense for people not to opt into the HSA, right? And so we just keep helping employers and then in kind of the perfect world, they allow us to then speak directly to their employees about the benefits, tax benefits and everything else around the health savings account. And, you know, with the deductibles narrowing like that, with the delta narrowing, it's really hard not to argue they should just sign up for it because they're going to basically close that gap on any contributions they can get from their employer and then also, of course, tax savings. So we just keep promoting it, and we're seeing some great uptake. Our relationship management team and our marketing team are doing a great job delivering that message. Our work is never complete. There are still employers and sectors that tend to be slower adopters, which means there's still a lot of fruit in the tree, but we're continuing to do everything we can to shake the trees. This is a great time of year, and we're making good progress on the messaging. So I'd say You know, thumbs up in both cases. Good new logo growth and then also good work with the enterprise team and actually good market in bringing on more growth.
spk07: That's fantastic. And can you just comment a little bit more about the competitive environment? I mean, obviously there's big players that may get consolidated, but then in addition to that, there's other big players, you know, with rates going up. You know, how should we think about, you know, service fees, you know, over the next year and things of that nature. Obviously, you're gaining more than your fair share of the market and continue to gain share. But just wondering if you can give us more comments on that.
spk08: Yeah, John, how do you want to break that up?
spk20: Why don't you talk about the competition piece and I'll hit the service fee discussion.
spk08: Perfect, yeah. So, you know, the competition has evolved a little bit, you know, partly because there's been some consolidation, as you mentioned. I mean, you know, a lot of these companies that we used to see as pretty good competitors, whether it be Wage or some of the more recent ones we've added, are now part of the health equity family, which is pretty awesome. And so, that being said, I mean, we do have some powerful competitors out there, but it's kind of the same message, you know. If somebody is buying... their healthcare services from a large health plan out there that is one of our competitors, then that large health plan will push pretty hard. We do win in that environment because I think people know that health equity has got this kind of single focus on empowering healthcare consumers. And that's kind of what's carried us now for 20 years, right, being that kind of independent single focus provider that can really nail the HSAs and the CDBs and with the bundle and things like that. You know, we have the same component thread on the retirement side, but that's where I think we more than level the playing field is with our partnerships, right? Because we've got a great, I mean, the health plan partnership list, I think is pretty storied in health equity land. And you all know that the success we've been able to have and take care of those health plan partners. And they bring us a lot of, even a broader footprint than you might get if you're a large health plan and you can kind of fish within your own pond. But we get to fish in many ponds. And then on the retirement side, we've got some great partners there too. So, look, I don't think it's evolved much. I'd love to see if John sees it differently, but it's kind of the same thing. It's just that it has been consolidating, and we've been, I think, up in our game on some of the things we're doing, like I mentioned earlier, around our product set and things like that.
spk20: Yeah, I mean, I love what's going on with the product. There's some really cool stuff that we're talking about with clients and working on and rolling out and that just is, I mean, it's not rocket science, but it is about helping consumers do the right things with these products and also helping employers understand what's actually going on within their base, not just in finance, but on the health side, you know, are people using the, the, the free stuff that they're supposed to be using in these plans, preventive, et cetera. Um, so I, I do think relative to what our competitors do, um, or the bulk of our competitors, we do more of it and we do more of it without dictating what the rest of your ecosystem is. And that's always been where we succeed. And, um, um, and I think, you know, we'll continue to succeed. Um, as far as pricing, you know, we are, as I think Jim commented in the prepared remarks, but certainly we're always going to be, you know, in an environment where the effective custodial yields continue to expand, and obviously balance continues to grow. You know, if you think about it, from the employer's perspective or whatnot, you know, one way to you know, the first place you look in terms of sort of a, you know, a cost elasticity is, you know, you look at the fees that you actually pay. And so, you know, we've done a number of things over time, I think quite successfully, to stabilize that. But, you know, we've, as Jim commented earlier, right, if you look at the current quarter, right, you've got, roughly speaking, you can do the math, you know, you've got a Uh, on a, if you look at total accounts on a unit basis, right, you've got, you know, give or take 5% lower year over year, about half of that is mixed and half of it is, is actual fee reduction. You know, the mixed stuff will come and go, you know, will we sell more HRAs versus FFCA next year? I don't know, but, but the, the, the fee component is there and we're going to roll with that. So I, I don't, I think, you know, we're, we're, we're trying to be, I think conservative in what we're assuming there are certainly realistic. because we don't really want to be losing business over fees. We want to be treating people fairly on fees, recognizing that particularly with our core product, there's a lot of ways to make money. At the same time, I think as you, and I'll stop, as you may recall, in some of our ancillary products where, you know, as a result of the wages, not wage works and such, we felt like profitability wasn't really there, you know, Cobra being the example, we had a very large project over the course of, and it's still, the impact of which is still rolling out and will help us a little bit next year. But nonetheless, to raise these. So we're not afraid to do it. We just want to do it where it makes sense. And where it makes sense is in areas like that. It makes sense for us to be competitive when it comes to HSAs. Last thing I'd say that gives us some level of stability here, but again, I don't think unit fees are rising substantially, but the stability is the diversity of our distribution. And what that does is it produces a client base that has enterprise where things are extremely competitive, as I've said before, because they come with assets and therefore, you know, you can underwrite that, you know, versus your smaller employers and the like where you can't do that. And so, you know, there's going to be more of a fee base. And then, of course, you know, you have retail. And so that level of diversity of distribution and of account and so forth, that actually also lends to stability in that service view line. So I guess that's a long way of saying our guidance reflects a little bit of conservatism there, consistent with kind of the numbers we're reporting here in terms of price impact, maybe not so much mix impact, but fundamentally, I think if you look at a big picture, it's a relatively modest price to pay for the benefits of what we see as ultimately a product that's obviously becoming more profitable, and you can see that in terms of what we're dropping the bottom line.
spk21: Thanks, Mark.
spk19: The next question comes from Jack Wallace with Guggenheim. Please go ahead.
spk13: Hi, Jack. Hey, how's it going? Congrats, Team Purple. Another great quarter.
spk04: Thank you.
spk13: We've got a couple of model monkey questions for you. I just wanted to make sure we're clearing up the yield understanding here. First one on, you know, when cash gets deployed, is it on a five-year duration or is it three years or is three years the duration of the book on average?
spk22: Want to hit this one, Jim? Yeah. I mean, you should, the answer is historically it's been yes, all of the above, three-, four-, five-year contracts, but I think you should generally be modeling five-year as our baseline investment product.
spk14: Excellent. That's helpful.
spk22: Yeah, using five-year treasury as your baseline rate.
spk13: Excellent. And then for the fourth quarter this year, it looks like there's an implied sequential step down in the daily cash AUM yield. Is that just related to some of the cash that's exposed to the front end of the curve, or is there something else going on there? Just thinking about also the comment earlier about a third of the AUM that gets repriced, so to speak, in December. I would think that would have a positive impact versus a negative one.
spk20: Yeah, I don't think there's a step down in Q4. I could be wrong. Maybe, Jim, if you have the numbers in front of you, if not.
spk22: Yeah, no, there's nothing that stands out. You're talking about the If you're talking about like the client held funds short end there, like we may see some dollars coming down, right, as the impact of our our statement that we talked about last quarter.
spk17: But no, we're not assuming any big shifts in the in the short rate. Maybe we can revert to you offline and make sure you've got the map right.
spk20: But to get to three next year, the HSA cash rate will be higher in Q4 than it has been here to date. And on CHF in Q4, I mean, you know what short rates are going to be in the rest of Q4. So there's not a lot going on there.
spk17: Thank you. Thanks, Jack.
spk15: This concludes our question and answer session.
spk19: I'd like to turn the call back to John Kessler for closing remarks.
spk20: I didn't know we were done. Wow. Okay. So I just wanted to say that I tried to get Jim in his opening remarks to say that Investor Day was going to be better than tax and he wouldn't do it. And I'm kind of bummed out about that. And if you care about making me feel better, then come to our investor day. And if you can't do that, or even if you can, we'll be at certain unnamed conferences in January, no doubt with Annie. And before that, we've got a bunch of other investor activity happening. This is a great time to be where we are. And the credit for that, in my mind, really does belong to our team, as well as to our clients and partners. I'm so pleased at what the level of partnership we're seeing with our employers and our health plans retirement plans and then the level of partnership on our team right now we're doing a lot of tough stuff behind the scenes to set the company up for expansion not just next year not just the following year but but for many years to come and um you may not see it all but it's a ton of work and it doesn't all go perfectly but it all gets done and it all gets done with people who are working really hard so I just wanted to spend a minute to say thank you on that.
spk15: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect. Thank you. you Thank you. Thank you.
spk23: Hello and welcome to the Health Equity Third Quarter 2024 Earnings Call. All participants will be in listen-only mode.
spk19: 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 from the queue, please press star then two. Please note, this event is being recorded. I would now like to turn the call over to Richard Putnam.
spk28: Thanks, MJ.
spk29: Hello, everyone, and welcome to HealthEquity's third quarter of fiscal year 2024 earnings conference call. My name is Richard Putnam. I do investor relations for HealthEquity. Joining me today is John Kessler, president and CEO, Dr. Steve Nealman, vice chair and founder of the company, and James Lucania, executive vice president and CFO. Before I turn the call over to John, I have two important reminders. First, A press release announcing the financial results for our third 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 the 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 5th, 2023. and will contain forward-looking statements as defined by the SEC, including predictions, expectations, estimates, or other information that might be considered forward-looking. There are many important factors relating to our business which could affect the forward-looking statements made today. These forward-looking statements are subject to risk and uncertainties that may cause our actual results to differ materially from statements made here today. We caution against placing undue reliance on these forward-looking statements. We also encourage you to review the discussion of these factors and other risks that may affect our future results or the market price of our stock, as detailed 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.
spk17: Now, over to John. Thank you, Richard.
spk20: Your emphasis on the word caution made me feel like you know more than you let on, but I know you know a lot. So, hello, everyone, and thank you for joining us, and happy holidays. I will discuss performance against Q3 key metrics and management's view of current conditions. Richard doesn't know anything more than he's letting on, by the way. Jim will detail Q3 financial results. And then he will provide our raised guidance for fiscal 24 and an initial outlook for fiscal 25. And Steve, of course, is here for Q&A. In Q3, the team delivered double-digit year-over-year growth in revenue, which was plus 15%. Adjusted EBITDA grew double that at 30%. HSA assets grew 12% year-over-year. And HSA members, again, also at fiscal quarter end, grew 8%. Total accounts grew 5%. Health equity ended Q3 with 8.3 million HSA members, 22.6 billion in HSA assets, and 15.3 million total accounts. Turning to sales, the team added 163,000 new HSA members in the third quarter, which narrowed the year-on-year gap relative to last year to 4% as we begin to lap the tour job growth and quit rates from Q1 and Q2. New logo growth, driven by a strong performance of our team, as well as our expanded network partner footprint, helped HSA growth in Q3 just as it has throughout fiscal 24 to date. HSA assets ended Q3 at $2.4 billion higher than a year ago, reflecting not only account but also balance growth. Sequentially, invested HSA assets declined during the fiscal quarter by $0.6 billion due to negative market action, and total assets therefore declined by the same amount. Members continue to invest their HSA balances, however, partially offsetting market declines. Year over year, 12% more of our HSA members became investors. helping to drive up invested assets by 21%. In fact, invested assets now account for nearly 40% of HSA assets. As you know, we believe that our members, our mission, and our long-term financial performance all benefit from the continued growth of investing in HSAs. We also continue to see more members choose enhanced rates for their HSA cash, leading to a higher or longer custodial yield, and we believe less cyclicality. While custodial fee growth drove Q3 revenue and margin performance, the team also delivered modest progress on the service line. Service costs actually declined year over year and sequentially, despite higher volumes of course, to help drive modest margin expansion. Interchange revenue grew strongly year over year and on a sequential basis and is now following its pre-COVID seasonal pattern as we expected, with strength in Q1 followed by softness in Q2 and especially in Q3. We expect sequential strengthening again in Q4. Our new CFO will detail our raised outlook for fiscal 24 and preview fiscal 25 in addition to providing more detail on Q3 results. You know, double-digit revenue growth and margin expansion is a pretty good first act. However, Jim would be quick to point out that health equity's current trajectory was years in the making. The team raised the trajectory of HSA growth by adding CDB capabilities at scale through wage works. It grew the value of HSA by pioneering affordable and accessible HSA investing and creating the enhanced rates program for HSA cash. It increased market responsiveness and resiliency by integrating with network, client, and ecosystem partners at every turn. And it enabled accretive allocation of your capital by uncovering HSA portfolio acquisitions, including Benefit Wallet, which upon completion will be our largest such transaction ever. Today, the team is innovating the value drivers of tomorrow. Applying cloud, API, data science, and yes, AI technology to HealthEquity's mission to save and improve lives by empowering healthcare consumers. With that, I will turn it over to Jim.
spk22: Jim. Thank you, John. First, let me say it's been a pleasure to join the HealthEquity team and have the opportunity to meet many of our investors over the past three months. The results we're reporting today are directly linked to the commitment our team makes every day to deliver purple service to our clients and members. I'll highlight our third quarter gap and non-gap financial results. As always, we provide a reconciliation of gap measures to non-gap measures in today's press release. Third quarter revenue increased 15% year over year. Service revenue was $107.5 million, down 1% year over year. Custodial revenue grew 43% to $106.6 million in the third quarter. The annualized interest rate on HSA cash was 258 basis points for the quarter. Interchange revenue grew 7% to $35.1 million. Gross profit as a percentage of revenue was 64% in the third quarter this year, up from 59% in the third quarter last year. Net income for the third quarter was $14.7 million, or 17 cents per share, on a GAAP EPS basis. Our non-GAAP net income was $52.2 million, or 60 cents per share for the third quarter, up versus 38 cents per share last year. While higher interest rates increased custodial yields and generated additional interest income, they also increased the rate of interest we pay on the remaining $287 million term loan A to approximately 6.7%. Adjusted EBITDA for the quarter was $95.6 million, An adjusted EBITDA as a percentage of revenue was 38%, more than 440 basis point improvement over the same quarter last year. For the first nine months of fiscal 24, revenue was $737.2 million, up 17% compared to the first nine months of last year. GAAP net income was $29.3 million, or 34 cents per diluted share. Non-GAAP net income was $140.5 million, or $1.62 per diluted share, up 69% compared to the same period last year. And adjusted EBITDA was $270.3 million, up 36% from the prior year, resulting in adjusted EBITDA as a percentage of revenue of 37% for the first nine months of this fiscal year. Turning to the balance sheet, as of October 31st, 2023, cash on hand was $334 million, boosted by $57 million of cash flow generated from operations in Q3 and $166 million year to date. The company had $874 million of debt outstanding net of issuance costs. We continue to have a $1 billion undrawn line of credit available. and we anticipate using both cash and drawing on the line of credit in fiscal 2025 in connection with the closing of the benefit wallet HSA acquisition. These strong results combined with expectations for our Q4 busy season allow us to raise fiscal 2024 guidance as follows. Revenue in a range between $985 and $995 million, GAAP net income in a range of $34 to $39 million or $0.39 to $0.45 per share. We expect non-GAAP net income to be between $181 and $188 million, resulting in non-GAAP diluted net income between $2.08 and $2.16 per share, based upon an estimated 87 million shares outstanding for the year. We expect adjusted EBITDA to be between $350 and $360 million. Our fiscal 2024 revenue increase is primarily based on revised expectations for the average yield on HSA cash to approximately 245 basis points for fiscal 24. As a reminder, we base custodial yield assumptions embedded in guidance on an analysis of forward-looking market indicators, such as the secured overnight financing rate, mid-duration treasury forward curves, and the Fed funds futures. These are, of course, subject to change. Our guidance also reflects the expectation of higher average interest rates on health equities variable rate debt versus last year, primarily offset by the reduced amount of variable rate debt outstanding. We assume a 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 expect positive GAAP net income this year. As we have discussed, moving the positive gap net income impacts our gap tax rate strangely this year. Discrete tax items may also impact the calculated tax rate on a low level of pre-tax income. Based on our current full-year guidance, we expect a gap tax rate for fiscal 24 slightly below 40%. As we have done in recent reporting periods, our full fiscal 2024 guidance includes a reconciliation of gap to the non-gap metrics provided in the earnings release, and a definition of all such items is included at the end of the earnings release. In addition, while the amortization of acquired intangible assets is being excluded from non-GAAP net income, the revenue generated from those acquired intangible assets is included. We're also providing the following initial guidance for fiscal year 2025. We expect revenue to be between $1.14 and $1.16 billion. We expect margins will expand with adjusted EBITDA growing to approximately 38% to 39% of revenue in fiscal 2025. This initial guidance is based on an estimated average HSA cash yield of about 3%. Based on our outlook of interest rate conditions, current forward yields for next year, and the anticipated migration of the benefit wallet HSAs in fiscal 2025. We expect benefit wallet ramp-up costs will, in effect, extend our busy season further into the new fiscal year than usual, with net positive impacts expected to begin by Q2. A reconciliation of our adjusted EBITDA outlook for the fiscal year ending January 31, 2025 to net income, its most directly comparable gap measure, is not included. because our net income outlook for this future period is not available without unreasonable efforts as we're unable to predict the ultimate outcome of certain significant items excluded from this non-GOT measure, such as depreciation and amortization, stock-based compensation expense, and income tax provision or benefit. Before we launch into Q&A, let me give another plug for our Investor Day scheduled for February 22nd at our offices in Draper, Utah. We expect to share information about HealthEquity's multi-year strategic initiatives to deliver remarkable experience, deepen partner relationships, and drive health and financial outcomes, and the impact we anticipate these initiatives may have on our business model and financial performance over the next several years. You will see product innovations being shared with our clients and partners, as well as a deep dive into our plans to accelerate the transition to enhanced rates. We're nearing capacity, so if you want to be there, and you do want to be there, you will need to register quickly. Please see our IR website or contact Richard. With that, we know you have a number of questions, so let's go right to our operator to kick off Q&A.
spk19: Thank you. 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. Our first question today comes from Greg Peters with Raymond James. Please go ahead.
spk25: Well, good afternoon, John, Steve, Jim, and Richard. Hello. I'll kick off the first question with the state of the market as it relates to M&A. I know you're working, will be working to close benefit wallet in the first half of next year. But another large competitor of yours, maybe more, have commented on the possibility of monetizing their HSA asset through a sale. So can you talk about what your appetite looks like for additional M&A and maybe just how you view your market players behaving in this environment?
spk20: Yeah, I mean, I think, first of all, thank you, Greg, for the question. I think the first point is that I think this reflects a trend that has been going on for a while, which is continued kind of, for lack of a better term, consolidation of the market around a couple of strong-scale players. And we're really pleased to be at the head of that trend. group at this point and have worked very hard for it over time. And one of the things that we've done over this period is really kind of honed our thinking about how we deploy shareholders' capital when we look at competitive transactions. And so we're in a very fortunate position that to the extent that something else is out there. And to the extent that, you know, one is that you should feel confident that we're going to be able to evaluate it effectively without, you know, kind of having to resort to, you know, investment banker magic. And that secondly, that, and I think BenefitWall demonstrates this, that we're going to shape transactions in a way that is a win for the seller, but also a win for our shareholders in terms of the timing of accretion and all that kind of thing so um i think that puts us in a good position if transactions kind of start to happen um i think secondly um you know if you if you will obviously talk about a little more at the investigate but i think um external models suggest that and certainly our forward guidance envisions that the company will continue to generate significant cash flow from operations and free cash flow generally, and that those numbers will only grow. So, you know, as I've said before, this is an ideal place for us to deploy capital in ways that generate real return to earnings. And ultimately, we believe to our shareholders. So we'd be very interested in that. that having been said, I think we also benefit from the fact that, you know, we've been beating these bushes for a very long time. And we also know where our, you know, sometimes why something comes to market, where our competitors might be more challenged. And those things are going to be reflected in our view evaluations. So, That's, I guess, my way of saying, Greg, that if you see something happen, you know, I don't know, mid-next year, late next year, and to be clear, I have no idea, genuinely. And it's not with us. It's not going to be because we didn't take a look at it. It's going to be because we carefully evaluated the price and decided not to do that, and we've done that in the past as well. So we're happy to hear those kind of rumors. We think they present great opportunities for our shareholders. We're also going to evaluate them carefully.
spk25: That makes sense. I have a follow-up question, assuming that Richard, the enforcer, will permit it.
spk20: Can I ask you a favor? I'll be the... Let's do one, but I want to... We did get more murmurings of challenges, and it's like Mr. Bigglesworth. We don't want you to be angry, so let's do one.
spk25: One follow-up?
spk20: Yeah.
spk25: Perfect. Just... You made a comment in your opening remarks about how the enhanced yield product will give you higher for longer custodial yield. One of the popular questions that comes inbound is how your custodial yield might perform if interest rates were to start to go down. So maybe you can help us explain what you meant by that comment. That's my last question.
spk21: Let me first, oh, actually, Jim, why don't you take this one?
spk22: Yeah, yeah, sure, I can. Yeah, so the, I mean, obviously, the initial outlook that we provided is based on forward-looking expectations of rates, and the market has for some time expected rates will come down next year, and that's reflected in our outlook, and we will have a small headwind We expect to have a small headwind on our client-held funds, right, the deposits that are really held short-term in overnight cash. So that's a small headwind to our yield next year. But we're still seeing the reinvestment rates at significantly higher rates than the cash is maturing at. So we are growing average HSA yields in a declining –
spk17: interest rate, short-term interest rate environment.
spk16: Okay, but in your comment, you said the enhanced yield gives it higher for longer.
spk25: I'm sorry. I've expired my two questions.
spk20: Thanks. I'm guessing there might be another one about this topic, so we're happy to go into one. Who's next?
spk19: The next question is from Stan Bernstein with Wells Fargo. Please go ahead.
spk09: Hi, thanks for taking my questions. Maybe first on the preliminary. Hi. On the preliminary guidance, I guess first, how should we think about the benefit wallet assets that are flowing in? Can you give us a sense of, you know, the timing of when these tranches are going to come in? To what extent are we getting the benefit through the year? And associated with that, Maybe I'll layer a couple more questions in here. Do you have to pay any fees on those assets moving into your custodial accounts? Let's start there.
spk20: Yeah, I think I can take this one. So let me start with the second part of your question, Stan. As you recall, in prior transactions, we've had a component where there's a seller, a third-party custodian that we have to pay. We had that in the WageWorks transaction. We have that here. technically the way it works in this case is it's the seller paying the fees and we have agreed as part of, and I think we disclosed this at the time the agreement was signed, we've agreed to cover, I believe, someone correct me if I'm wrong, $20 million of such fees within the purchase price. So that doesn't impact our projection of go-forward income or the income statement in any way. It's just a purchase price accounting issue. And then with regard to the first part of your question, the way to think about this, I think, is that, and Jim mentioned this briefly in his opening remarks, is that we will see incremental service expense effectively our busy season extending into the first bit of the fiscal year, as we prepare to bring on these accounts, it would be silly to fully ramp down and then ramp back up again. So there'll be some, and even if we were doing that, we would still see incremental costs. So you'll see some incremental service costs. And then in Q2, we should start to kind of net out to a positive here as we begin to onboard these accounts. And so our guidance kind of reflects that idea that these transitions will occur kind of in that time frame, and by the second half of the year, we'll be at run rate. And as we've discussed elsewhere, this kind of accretes very quickly. So if that's helpful for you, we can't I would say there's some uncertainty here, as there often is, but that's our current expectation.
spk09: That's helpful. Thank you. Maybe just a quick one on services gross margin. Clearly, you're making some progress here. Can you maybe share any updates on the adoption of your text-based communications with your members and whether or not you're recognizing some tangible improvements on the gross margin side there?
spk20: Yeah. Well, Jim talked about the progress on gross margin generally. I think, obviously, if you look at service expense and the like, the ability to kind of be in a good spot here relative to volume growth speaks to the point that you're making, particularly given that we're also fighting things like wage growth that are headwinds in this area. And so, yeah, I commented elsewhere that we've made, we look at this month over month and what we're really trying to do is ultimately it's not just, it's in part the the move from voice to chat, but it's also ultimately the move from live to automated in areas where members really get value out of that. And there are clearly a lot of those. And so we continue to see kind of, I would just say quarter over quarter progress. It's not, and we've never suggested it was a magic bullet, but the ultimate opportunity to take significant costs out of service delivery while delivering actually a better experience for members through digitization. This is, as I've said elsewhere, is a no-brainer in terms of, it's sort of ironic to say this, in terms of the applications for generative alternative AI. It just, you know, damn, this stuff really works. And so we think that that will continue and we think that what we do is actually an excellent application for it because precisely because it's not, you know, it's always as simple, and people's questions aren't always as, you know, formed in exactly the same way, and yet you want to be able to generate the right answers. Thanks, Dan.
spk19: Thank you. The next question is from Alan Lutz with Bank of America. Please go ahead.
spk10: Hey, Alan. Thanks for taking the questions, and welcome, Jim. A couple on the financial side. So I just want to... Ask on the 3% custodial yield guide for next year, how much of those contracts have already been set? And then one follow-up related to the financials, is benefit wallet fully incorporated into the fiscal 25 guide? And then I have a follow-up.
spk20: That sounds like three.
spk10: That's three.
spk22: Yeah, so as John said, our expectation about both the ramp-up cost, the transition cost, migration cost, and then, of course, the benefit of having the accounts on our platform are built in to the 2025 guide, as are those assets will be invested at market rates, which will obviously pull up the average rate earned on HSA yield. So yes, benefit wallet is a contributor to revenue and to the higher yield that we're going to be guiding to here.
spk20: And then just as to the first part of your question about placements, the math is a little different with enhanced rates now where we can do placements you know, throughout the year. So it's a little less relevant, but a way to think about it is that – we will do – we do placements mostly when money moves in terms of when rates are cut. So about a third of that happens in the – if you sort of think about that year-end bulk, about a third of it's in fiscal Q4, or I'm sorry, calendar Q4, and then two-thirds is kind of in that January period. But I would caution that – I just want to say I would caution on that last point. Enhanced rates does have a benefit that allows us to draw that out a little bit. And so over time, what you'll have to get used to is – and I think this will be good – is that it's not going to be sitting and waiting for what the rate is on a given day. It's going to matter as much for those kinds of placements.
spk15: Thank you. The next question comes from David Larson with BTIG. Please go ahead.
spk06: Hi. Congratulations on an excellent quarter. Can you maybe just talk a little bit about expectations for yield longer term? Obviously, I wouldn't ask for guidance for fiscal 26, but since it takes three years to recontract your book of business, let's say rates hold steady or decline slightly. next year, maybe they decline slightly in fiscal 26. Could your yield still go up, which would obviously benefit custodial in fiscal 26?
spk22: Jim, you want to hit this one? Simple answer is yes. Obviously, it depends how far rates decline. But yeah, I think you said if rates remain stable, then yes, we'd expect the average rate to continue. They're There are strong tailwinds in that number.
spk20: The key issue is that one of the things that we really do get benefit of, if you think about it, I appreciate your point about three years, but think about the duration contracts. You think about what we're going to be replacing next year. Those duration contracts next year will be the first ones that we're replacing right, that are pandemic era. So the stuff that's being repriced is going to be repriced in, you know, very favorably. And beyond that, you know, if I take current market projections about where rates will be in a year or what have you, as sort of, you know, consistent with your question, we will still be placing new money at rates well above our current guide of three percent and so those will continue to be you know i think pretty significant tailwinds for uh yield for quite some time actually you know again without wanting to give particular guidance i mean those are the key factors and um it's what you can replace money at relative to what you had it at before and what you're placing new money at and um both of those appear to be tailwinds for quite a while under any current reasonable scenario over the course of the next several years.
spk06: Okay, great. And I think Richard will allow me one more maybe. So it was nice to see the interchange revenue up, I think, 7% year-over-year. For service revenue, I think it was down maybe 1% year-over-year, but But I think there's some unusual things causing that. When should we expect to see growth in service revenue sort of return to a more normalized rate? What is the driver of that? And what would you expect sort of that longer-term normalized service revenue growth rate to be? Thanks very much. Want to hit that one, Jim?
spk22: Yeah, sure. I can take that one. Yeah. So I think, yeah, you really hit right on the story for Q3. We've effectively – help serve on that line with revenue slightly down, cost slightly down, the margin slightly up. But there's a lot of moving parts and stories within that, within those headline numbers. So you sort of look at it, and we do look at it by product, and you see a price volume mix story occurring there where price has been a headwind, especially in R.A., As buyers look at this as a bundle, really, they understand we're making much higher revenue on the custodial cash and the HSA cash. They understand we're making good margin on the interchange, and this is the release valve on price. So we're seeing a little bit of price per unit price headwind here. we see the impact of the mix shift, especially towards HSA. As we're growing HSA significantly higher, that's always been the lowest fixed dollar fee product as it's got the highest percentage of interchange and custodial revenue attached to it. So as our business mix towards that, we're going to see that pressure on the revenue line and that margin line. And you can call that sort of a half and half impact price and mix and then being offset by our much higher volumes. So negative price, negative mix, positive volume, that's out to just about a million dollar delta on the revenue line.
spk12: Thanks, David.
spk19: The next question is from Ann Samuel with JP Morgan. Please go ahead.
spk27: Hi guys. Congrats on the quarter. And thanks for the question. Um, you know, in the past you've kind of talked about a gradual increase for your deposits going into the enhanced rates product, but you know, with benefit wallet, you're going to see kind of a big jump up in that, you know, that mix, um, you know, are you where you want to be now? Or should we expect that to continue to, you know, kind of increase as a percentage of the mix over time? You know, where are you hoping to get with that?
spk20: Uh, you should expect it to increase as a percentage of the mix over time. And, um, If you're willing to make the step out to Salt Lake City or listen in, I think we'll talk more about that so people can get a clear view of it over time. But we're extremely pleased with a couple of aspects of this program. One is that... is that on a voluntary basis, the consumer adoption has been great. I think consumer acceptance of what we're trying to do has been great. I feel like employers, those who pay attention to this, understand that the fact that we've done this has really kept us from having to impose other costs on them and also see us reinvesting in the business. I'm extremely pleased with I just don't know how to say it any other way, with the work that the team has done to educate the best possible partners we can have for this product. We went into this with the biggest question in our mind was actually what's going to be the receptivity within what is appropriately a very conservative market on the insurance side to a product that has a lot of great attributes for them, but they just haven't had them before. And the receptivity has been great. It's been great among very high-quality names. And the stable there continues to grow. And so we're absolutely looking at options to accelerate, if anything, the shift into this product. And we'll talk a little more about that, I'm guessing, at the Investor Day and its impact in the out years.
spk27: That's really helpful, then. And I guess as we kind of think about, you know, as you get bigger and bigger with this product, is it still right to think of it as kind of a 50 to 75 basis point premium to your kind of traditional yield, or can that change over time as well?
spk20: I think that's still probably right.
spk17: I mean, it's... I think that's still probably right.
spk19: Thanks, Anne. The next question comes from George Hill with Deutsche Bank. Please go ahead.
spk02: Hey, good evening, guys. Good evening. And just a couple of housekeeping questions, actually, for me. I guess, number one, John or Jim, could you guys talk about the expected EBITDA contribution from Benefit Wallet in fiscal 25? And my follow-up is I know you guys have some lumpiness of, uh, cash rolling off to be redeployed as we look out over the next 12 to 18 months. Can you just kind of remind us on the, on the big pieces that kind of, that kind of come off being committed and get recommitted, um, and so we can kind of fine tune our, our models around the waterfall. Thanks for that.
spk20: Thanks. Why don't I, you want me to take the first half and you take the second half, Jim? Sure.
spk11: Yep. Sure.
spk20: Okay. Um, so, uh, A way to think about benefit wallet is that, you know, as I suggested earlier, you know, we're going to get a little bit more than half a year impact. Maybe you could say, I don't know, maybe say two-thirds of a year impact. I don't know. Somewhere around there this year. And this product, you know, this transaction, like prior transactions we've done, is is um you know it's going to be highly accretive so um it's certainly uh we were already anticipating that we would be delivering um a a nice uh implied boost in in uh even margins and um i think this has just helped us accelerate for lack of better term you know where we ultimately felt we would get to um as we have you know accounts mature and and so forth so You know, the way I think about the first question is, and I would, you know, encourage someone to do their own modeling, but I think, you know, I remember, George, you asking me several years back, you know, whether the company could return at some point. And I think you were being a little bit, what's the word I want? You were sort of poking me a little bit saying, you know, can you guys return to even the margins with a forehandle? we're offering guidance right now for next year between 38, 39. And, um, so, um, this has sort of accelerated some of that process and, and, uh, uh, that seems like a good thing. Uh, Jim on the second half, you want to take that one, which was about, I think about the timing of, of, uh, uh, asset redeployment.
spk22: Yep. Yeah, exactly. Reinvestments in that. Yeah, you're exactly right. Like the, um, there's, there's sort of a block of, of wage, um, bumps in assets that are going to be maturing actually not so much in next fiscal year. We've got a relatively smaller block of assets maturing Q4 of this year and throughout next fiscal year, and it will be the following two years where some of those lumpier blocks are going to be maturing. Being reinvested is a better word to say.
spk20: Thanks, George. A way to think about that is since we deployed the original wage assets in, I'm going to say, calendar 21, no, calendar 20, and the kind of core piece of that is five-year, right? You'll see a lot of that rollover in the middle of calendar 25. There's a little of it this year, but you get the idea.
spk17: And we'll roll over well because we all know where we were in 2020. Sorry.
spk18: The next question comes from Mark Markun with Baird. Please go ahead.
spk07: Hey, good afternoon, and thanks for taking my question. And let me add my congratulations. I'm just wondering if you can talk a little bit about, you know, you had good new logo sales. I'm wondering if you can talk a little bit more about what you're seeing on the enterprise side, just in terms of both from a competitive perspective, but also in terms of the desire to shift, you know, part of the employee population to, you know, HDHPs, you know, particularly in light of the accelerating, you know, healthcare costs that are coming through. And then I've got a follow-up.
spk08: Do you want to hit this one? Sure. Happy to. Hey, Mark, how are you? I expect you'll be out in February. Absolutely. Because we did get our first big snowstorm this weekend. Anyway, so kind of in order, yeah, I mean, we talked about in the comments that we're seeing some good progress on bringing on these new enterprise logos. And this has been a lot of work, put a lot of time into it. We've not only refined our marketing message and brought on some great sales team members that are hustling there, but also I think our product, Sweet is continuing to evolve to take care of their needs. I mean, we're doing some really nice things there. So I think the bottom line is we're pleased with the progress we've made in the new logos. Now, I'm continually amazed. And maybe it's just because, as you know, Mark, every year, I'll tell you a little fact that this is from the Kaiser study. The average high deductible plan that is HSA qualified is in the country is about $4,800 for a family plan. And the average non-HSA deductible, let's say for a PPO plan, is about $2,900. So as those numbers keep getting closer, it really doesn't make a heck of a lot of sense for people not to opt into the HSA, right? And so we just keep helping the employers and then in kind of the perfect world, they allow us to then speak directly to their employees about the benefits, tax benefits and everything else around the health savings account. And, you know, with the deductibles narrowing like that, with the delta narrowing, it's really hard not to argue they should just sign up for it because they're going to basically close that gap on any contributions they can get from their employer and then also, of course, tax savings. So we just keep promoting it, and we're seeing some great uptake. And our relationship management team and marketing team are doing a great job delivering that message. And so our work is never complete. There are still employers and sectors that tend to be slower adopters, which means there's still a lot of fruit in the tree, but we're continuing to do everything we can to shake the trees. And this is a great time of year, and we're making good progress in messaging. So I'd say. You know, thumbs up in both cases. Good new logo growth and then also good work with the enterprise team and actually new market and bringing on more growth.
spk07: That's fantastic. And can you just comment a little bit more about the competitive environment? I mean, obviously there's big players that may get consolidated, but then in addition to that, there's other big players, you know, with rates going up. You know, how should we think about, you know, service fees, you know, over the next year and things of that nature. Obviously, you're gaining more than your fair share of the market and continue to gain share. But just wondering if you can give us more comments on that.
spk08: Yeah, John, how do you want to break that up?
spk20: Why don't you talk about the competition piece and I'll hit the service fee discussion.
spk08: Perfect, yeah. So, you know, the competition has evolved a little bit, you know, partly because there's been some consolidation, as you mentioned. I mean, you know, a lot of these companies that we used to see as pretty good competitors, whether it be Wage or some of the more recent ones we've added, are now part of the health equity family, which is pretty awesome. And so, that being said, I mean, we do have some powerful competitors out there, but it's kind of the same message, you know. If somebody is buying... their healthcare services from a large health plan out there that is one of our competitors, then that large health plan will push pretty hard. We do win in that environment because I think people know that health equity has got this kind of single focus on empowering healthcare consumers. And that's kind of what's carried us now for 20 years, right, being that kind of independent single focus provider that can really nail the HSAs and the CDBs and with the bundle and things like that. You know, we have the same threat on the retirement side, but that's where I think we more than level the playing field is with our partnerships, right? Because we've got a great, I mean, the health plan partnership list, I think is pretty storied in health equity land. And you all know that the success we've been able to have and take care of those health plan partners. And they bring us a lot of, even a broader footprint than you might get if you're a large health plan and you can kind of fish within your own pond. But we get to fish in many ponds. And then on the retirement side, we've got some great partners there too. So, look, I don't think it's evolved much. I'd love to see if John sees it differently, but it's kind of the same thing. It's just that it has been consolidating, and we've been, I think, up in our game on some of the things we're doing, like I mentioned earlier, around our product set and things like that.
spk20: Yeah, I mean, I love what's going on with the product. There's some really cool stuff that we're talking about with clients and working on and rolling out and that just is, I mean, no, it's not rocket science, but it is about helping consumers do the right things with these products and also helping employers understand what's actually going on within their base, not just in finance, but on the health side, you know, are people using the, the, the free stuff that they're supposed to be using in these plans, preventive, et cetera. Um, so I, I do think relative to what our competitors do, um, or the bulk of our competitors, we do more of it and we do more of it without dictating what the rest of your ecosystem is. And that's always been where we succeed. And, um, um, and I think, you know, we'll continue to succeed. Um, As far as pricing, we are, as I think Jim commented in the prepared remarks, but certainly we're always going to be in an environment where the effective custodial yields continue to expand. And obviously, balance continues to grow. If you think about it, from the employer's perspective or whatnot, one way to you know, the first place you look in terms of sort of a, you know, a cost elasticity is, you know, you look at the fees that you actually pay. And so, you know, we've done a number of things over time, I think quite successfully, to stabilize that. But, you know, we've, as Jim commented earlier, right, if you look at the current quarter, right, you've got, roughly speaking, you can do the math, you know, you've got a If you look at total accounts on a unit basis, you've got give or take 5% lower year over year. About half of that is mixed and half of it is actual fee reduction. The mixed stuff will come and go. Will we sell more HRAs versus FFCAs next year? I don't know. But the fee component is there and we're going to roll with that. We're trying to be, I think, conservative in what we're assuming there is certainly realistic. because we don't really want to be losing business over fees. We want to be treating people fairly on fees, recognizing that, particularly with our core product, there's a lot of ways to make money. At the same time, I think as you, and I'll stop, as you may recall, in some of our ancillary products where, you know, as a result of the wage stuff, wages, not wage works, and such, we felt like profitability wasn't really there, you know, Cobra being the example, we had a very large project over the course of, and it's still, the impact of which is still rolling out and will help us a little bit next year. But nonetheless, to raise these. So we're not afraid to do it. We just want to do it where it makes sense. And where it makes sense is in areas like that. It makes sense for us to be competitive when it comes to HSAs. Last thing I'd say that gives us some level of stability here, but again, I don't think unit fees are rising substantially, but the stability is the diversity of our distribution. And what that does is it produces a client base that has enterprise where things are extremely competitive, as I've said before, because they come with assets and therefore, you know, you can underwrite that, you know, versus your smaller employers and the like where you can't do that. And so, you know, there's going to be more of a fee base. And then, of course, you know, you have retail. And so that level of diversity of distribution and of account and so forth, that actually also lends to stability in that service view line. So I guess that's a long way of saying our guidance reflects a little bit of conservatism there, consistent with kind of the numbers we're reporting here in terms of price impact, maybe not so much mix impact, but fundamentally, I think if you look at it big picture, it's a relatively modest price to pay for the benefits of what we see as ultimately a product that's obviously becoming more profitable, and you can see that in terms of what we're dropping the bottom line.
spk21: Thanks, Mark.
spk19: The next question comes from Jack Wallace with Guggenheim. Please go ahead.
spk13: Hi, Jack. Hey, how's it going? Congrats, Team Purple. Another great quarter.
spk04: Thank you.
spk13: We've got a couple of Model monkey questions for you. I just wanted to make sure we're clearing up the yield understanding here. First one on, you know, when cash gets deployed, is it on a five-year duration or is it three years? Or is three years the duration of the book on average?
spk22: Want to hit this one, Jim? Yeah. I mean, you should, the answer is historically it's been, yes, all of the above, three-, four-, five-year contracts, but I think you should generally be modeling five-year as our baseline investment product.
spk14: Excellent. That's helpful.
spk22: Yeah, using five-year treasury as your baseline rate.
spk14: Excellent.
spk13: And then for the fourth quarter this year, it looks like there's an implied sequential step down in the daily cash AUM yield. Is that just related to some of the cash that's exposed to the front end of the curve, or is there something else going on there? Just thinking about also the comment earlier about a third of the AUM that gets repriced, so to speak, in December. I would think that would have a positive impact versus a negative one.
spk20: Yeah, I don't think there's a step down in Q4. I could be wrong. Maybe, Jim, if you have the numbers in front of you, if not.
spk22: Yeah, no, there's nothing that stands out. You're talking about the If you're talking about like the client held funds short end there, like we may see some dollars coming down, right, as the impact of our our statement that we talked about last quarter. But no, we're not assuming any big shifts in the in the short rate.
spk20: Maybe we can revert to you offline and make sure you've got the map right. But to get to three next year, the HSA cash rate will be higher in Q4 than it has been year to date. And on CHF in Q4, I mean, you know what short rates are going to be in the rest of Q4. So there's not a lot going on there.
spk17: Thank you. Thanks, Jack.
spk15: This concludes our question and answer session.
spk19: I'd like to turn the call back to John Kessler for closing remarks.
spk20: I didn't know we were done. Wow. Okay. So I just wanted to say that I tried to get Jim in his opening remarks to say that Investor Day was going to be better than tax and he wouldn't do it. And I'm kind of bummed out about that. And if you care about making me feel better, then come to our investor day. And if you can't do that, or even if you can, we'll be at certain unnamed conferences in January, no doubt with Annie. And before that, we've got a bunch of other investor activity happening. This is a great time to be where we are. And the credit for that, in my mind, really does belong to our team, as well as to our clients and partners. I'm so pleased at what at the level of partnership we're seeing with our employers and our health plans, retirement plans, and then the level of partnership on our team right now. We're doing a lot of tough stuff behind the scenes to set the company up for expansion, not just next year, not just the following year, but for many years to come. And you may not see it all, but it's a ton of work and it doesn't all go perfectly, but it all gets done. And It all gets done with people who are working really hard. So I just wanted to spend a minute to say thank you on that.
spk15: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
Disclaimer