Healthequity, Inc. Q1 FY2023 Earnings Call

Good day, and thank you for standing by, and welcome to HealthEquity First Quarter 2023 Earnings Call. I would now like to hand the conference over to your host today, Richard Putnam.

Thank you, Justin. Good afternoon, welcome to HealthEquity's first fiscal year 2023 earnings conference call. My name is Richard Putnam. I do Investor Relations here for HealthEquity and joining me today is Jon Kessler, President and CEO; Dr. Steve Neeleman our Vice-Chair and Founder of the Company; Tyson Murdock, the company's Executive Vice President and CFO; and Ted Bloomberg, Executive Vice President and Chief Operating Officer. Before I turn the call over to Jon, I have two important reminders. First, a press release announcing our financial results for the first quarter of fiscal year 2023 was issued after the market closed this afternoon. The financial results in this press release includes contributions from our wholly-owned subsidiary WageWorks and accounts it administers. The press release also includes definitions of certain non-GAAP financial measures that we will reference today. A copy of today's press release, including reconciliations of these non-GAAP measures and the comparable GAAP measure and a recording of the webcast can be found on our Investor Relations website, which is ir.healthequity.com. Second, our comments and responses to your questions today reflect management's view as of today June 6, 2022, and will contain forward-looking statements as defined by the SEC, including predictions, expectations, estimates, or other information that might be considered forward-looking. There are many important factors relating to our business, which could affect the forward-looking statements made today. These forward-looking statements are subject to risks and uncertainties that may cause our actual results to differ materially from the statements made here today. We caution against placing undue reliance on these forward-looking statements and we also encourage you to review the discussion of these factors and other risks that may affect our future results, as well as our market price of our stock detailed in our latest Annual Report on Form 10-K and any subsequent periodic reports filed with the SEC. We assume no obligation to revise or update these forward-looking statements in light of new information or future events. At the conclusion of our prepared remarks, we will open up the call for Q&A with the help of our operator. I'll now turn the call over to our CEO, Jon Kessler.

Thank you, Richard. Well done as always. Hello, everyone, and thanks for joining us this lovely afternoon. Today, we are announcing a strong start to HealthEquity’s fiscal '23 with results for the first quarter ended April 30. I will discuss our Q1 results, and then I've got my three amigos with me here. Ted will review operations, Tyson will review the financial details of the quarter and provide updated guidance, and Steve will be here for Q&A. Looking first to the five key metrics that drive our business. Revenue grew 12% to $205.7 million versus $184.2 million in the first quarter of last year, which reflects our recent acquisitions and growth and accounts and assets. Adjusted EBITDA of $58.3 million was down 1% from the first quarter last year of $59.0 million as we exited Q4 busy season with higher than normal service staffing levels and lower year-over-year custodial yields versus the year ago. HSA members reached $7.4 million, up 26% year-over-year, including 12% organically and HealthEquity HSA members grew their assets to a record $20.3 billion at quarter's end, up an even larger 35% from a year ago. Total accounts grew to 14.5 million at quarter's end. Team Purple started fiscal '23 with very strong sales results, including a fiscal first quarter record of 159,000 new HSAs, up 38% from 115,000 new HSAs opened in Q1 of last year. HSA investments grew a net $650 million in the quarter and HSA members grew 36% year-over-year, even with the substantial market headwinds that we're all aware of as members and their employers continue to contribute and invest. The average balance of HSA members is up a healthy 7% year-over-year, notwithstanding the above headwinds. Also in Q1, we welcomed members from Health Savings Administrators, which was the 11th largest HSA administrator on Devenir's 2021 lead tables in its year-end market report. And adding as reported by Devenir, Health Savings Administrators assets to HealthEquity would place HealthEquity at the top of the league table in terms of both account and asset market share, that’s good. As Tyson will detail, custodial yields in Q1 were stronger than previous guidance, driven by our members continuing to place more of their HSA cash in our enhanced rates product and by monetary tightening by central banks so far this year to contain inflationary pressures. HealthEquity and our team members are subject to those pressures as well of course, but we expect the incremental revenue from higher yields will drive increased profit and reduce leverage, even as we invest in our platform for future growth. I will now turn the call over to Ted to review operations.

Thanks, Jon. I'm happy to report sales are continuing their record-setting pace. You just heard from Jon, net sales were up 38%, compared to last year's first quarter, driven by organic growth rates and strong performance in the mid-market space. Our partner sales efforts are paying off and we have been the beneficiary of healthy hiring trends among our clients. The work we've done over the last two years on our engagement messaging has helped us become an ally to our clients as they seek to fight cost pressures while increasing the value and attractiveness of their employee benefits. With peak season behind us, our hardworking Purple Army is wrapping our arms around our members, clients, and partners and developing new ways of servicing them. We're making investments as part of our commitment to Purple program to meet our constituents where they are, such as expanding our chat capabilities, deploying self-service tools that are resonating with our members, and making it easier to start or deepen our relationship with us. In client service, process improvements and self-service are driving down average issue resolution time year-over-year. And on the broker side, we have developed a relationship model for top offices that allows them a single point of contact for anything they might need or request from brokers that we were able to deliver this quarter. We know that Purple service is the best salesperson and we will continue to invest here. Those service improvements have been enabled by our aggressive approach to integrations over the past few years, migrating clients and members from over a dozen platforms to three core platforms for HSA, COBRA, and CDB. These efforts helped us achieve $80 million in run rate synergies, allowed us to invest back into the business even during a low interest rate environment, and provided an improved customer experience. The team is now focused on doing the same for our Further acquisition, consolidating teams and platforms to ensure a Purple experience and achieving synergies and cost savings along the way. As mentioned previously, we exited busy season more heavily staffed than usual. The work to address this is now substantially complete. Finally, we're innovating on the product side as well. For example, as employers adjust to the new normal and build return to office programs, we are right there with them promoting a variety of lifestyle accounts in employer-sponsored plans that allow them to attract and retain talent in a competitive job market with unique and innovative offerings. We are well positioned to offer more of these accounts because we have a long track record of delivering both pre-tax and post-tax benefits in an engaging and simple way. There is much more work to be done, but we are pleased with our progress. A huge thank you to the HealthEquity team for what you have accomplished and all that you will accomplish moving forward. Now, I'll turn it over to Tyson for a closer review of the financials.

Thanks, Ted. I will review our first quarter GAAP and non-GAAP financial results, a reconciliation of GAAP measures to non-GAAP measures is found in today's press release. First quarter revenue increased 12% benefiting from a record fiscal '22 selling season, recent acquisitions, a better-than-expected rate environment, and as members increased spending. Service revenue increased 2% to $104.3 million, representing 51% of total revenue in the quarter. The increase is primarily attributable to growth in HSA and the addition of the Further acquisition, partially offset by a decrease in CDB service revenue. Custodial revenue grew 26% to $59.4 million in the first quarter, compared to $47 million in the prior year first quarter as 28% growth in average HSA cash and 47% growth in average HSA investments more than offset a 10 basis point decline in the annualized yield on HSA cash. HSA Asset growth benefited from a strong selling season and multiple HSA portfolio and other acquisitions completed since the first quarter of last year. The annualized interest rate yield was 169 basis points on HSA cash during the first quarter of this year. This yield is a blended rate for all HSA cash during the quarter and represents a better-than-expected yield. The HSA Asset table of today's press release provides additional details. You will notice a slight change in our presentation in that we no longer break out HSA cash with and without yield. We have completed all HSA asset migrations related to WageWorks for the all HSA cash as instruments providing yield. Interchange revenue grew 21% to $42 million, representing 20% of total revenue in the quarter. The interchange revenue increase was primarily due to strong sales and M&A during the past year, driving growth in average total accounts, as well as a modest increase in spend per account across our platforms in the quarter. Gross profit was $111.2 million, compared to $103.1 million in the first quarter of last year. Gross margin was 54% in the quarter. We previously discussed that the service cost included $5 million to $7 million of expense primarily incurred in Q1 due to maintained elevated servicing capacity in Q1 in response to record sales volumes, portfolio acquisitions, platform integration activity, and pandemic-related attrition and other risks. Operating expenses were $118.5 million or 58% of revenue, including amortization of acquired intangible assets and merger integration expense, which together represented 16% of revenue. Loss from operations was $7.3 million. Net loss for the first quarter was $13.6 million or a loss of $0.16 per share on a GAAP EPS basis, compared to a net loss of $2.6 million or $0.03 per share in the prior year. Our GAAP, non-GAAP net income was $22.7 million for the first quarter of this year, compared to $31 million a year ago. Non-GAAP net income per share was $0.27 per share, compared to $0.38 per share last year. Adjusted EBITDA for the quarter was $58.3 million and adjusted EBITDA margin was 28%. Turning to the balance sheet as of April 30th, 2022, we had $161 million of cash and cash equivalents with $929 million of debt outstanding, net of issuance costs with no outstanding amounts drawn on our $1 billion line of credit. Based on where we ended the first quarter and our current view of benefits and the economic environment, we are providing the following revision to our guidance for fiscal '23. Revenue for fiscal '23 to range between $827 million and $837 million, non-GAAP net income to be between $103 million and $111 million, resulting in non-GAAP diluted net income between $1.23 and $1.32 per share based upon an estimated 84 million shares outstanding for the year, and adjusted EBITDA to be between $249 million and $259 million. Today's guidance includes our most recent estimate of service, custodial, and interchange revenue based on results to date. Our guidance assumes a yield on HSA cash of approximately 170 basis points and includes only the actions that Fed has taken to date and excludes any additional broadly anticipated Fed actions for the remainder of this year. Changes in rates before the end of our fiscal year will only benefit the HSA cash that is in short-term floating-rate vehicles in fiscal '23, but may have a much greater impact on fiscal '24 and beyond as we roll over fixed rate contracts and place new HSA cash coming in from open enrollment at the end of the year. While we don't give quarterly guidance, looking forward to the second quarter, we want to remind you that the second quarter last year included non-recurring revenue items related to pandemic relief legislation. First, we will not have COBRA subsidy work in Q2 this year. Second, we are not expecting Q2 interchange revenue growth comparable to last year when our members were using rollover FSA dollars in advance of the expiration of pandemic relief. We continue to be conservative in our commuter outlook with limited return to work modeled into our guidance. We have seen three straight quarters of modest increases in commuter accounts but remain cautious about modeling in an aggressive rebound. Our guidance today also includes the impact of inflation on our service cost and an increase in expense for the resumption of travel by our sales team and a modest inflationary increase in engineering and security costs. The outlook for fiscal '23 assumes a projected statutory income tax rate of approximately 25% and a diluted share count of 84 million. As we have done in recent reporting periods, our full-year guidance includes a detailed reconciliation of GAAP to the non-GAAP metrics provided in the earnings release, and a definition of all such items is included at the end of the earnings release. In addition, while the amortization of acquired intangibles is being excluded from non-GAAP net income, the revenue generated from those acquired tangible assets is not excluded. And with that, I'll turn the call back over to Jon for some closing remarks.

Thank you, Tyson well done. HealthEquity finds itself in a far better position today than it did a few quarters ago, and that's a function of the hard work of the team, as well as previous interest rate, pandemic, and integration headwinds starting to become tailwinds for the business. As I watch CNBC or whatever, the current macro environment might be forcing other technology-driven growth companies to scale back, for HealthEquity and our team, it really gives us the opportunity to lean in, and that's what we're going to do. So with that, let's open the call up to questions, operator?

Thank you. Our first question comes from Anne Samuel from JPMorgan. Your line is now open.

Hi, good afternoon, guys. Congrats on a great quarter.

Thank you.

I was hoping, if you could touch a little bit on the enhanced rates product. Just wondering how much of the higher yield was just due to better penetration there? And then maybe what are some of the drivers of that penetration of enhanced yields coming in better than you expected?

Yes. Hey, Anne. The higher yields really relate to the variable component of the HSA cash that we have. And so when you think about the Fed increases since we last reported of about 50 basis points, that's really the increase on top of just the goodness we saw for Q1 and that's really what that is. From an enhanced rate perspective, I'll let Ted talk a little bit about penetration there. Ted?

Sure. Hi, Anne. We've been undergoing a series of different efforts in order to educate our members and clients and other constituents about the availability of the enhanced rates program, and all of those are conspiring to put us in pretty good shape to hit that year-end 20% target for cash in enhanced rates. Some of that engagement on the website, in the app, when you call us, some of it is how we talk to clients and partners about how they can offer it, and a lot of it is new sales where the enhanced rate offering is the default. So those are sort of the three big tools that we're using in order to achieve that goal of 20% of our cash in enhanced rates by the end of the year.

That's really helpful. Thank you. And then, Jon, you commented a little bit on the macro environment, things have obviously changed somewhat since your last call when you talked about labor shortages driving HSA adoption. I know you're not planning on making any changes at your company, but are you seeing anything maybe within your customers around adoption? Thanks.

In the first quarter, we experienced significant hiring, which contributed to our HSA sales. While I don't have a clear insight into the future, I can observe the same news and information as everyone else. As Ted mentioned, it’s important to consider. With efforts to slow the economy, we can all interpret what that means for us. For HealthEquity, there are a few key points: HSAs and CDBs benefit everyone. When employees contribute to these products, they save money, and so do our clients since these contributions are exempt from payroll tax. Additionally, HSAs are part of a broader strategy to manage costs effectively. In the event of a recession, which may prompt employers and employees to prioritize cost-cutting, we believe our offerings will be beneficial. Importantly, our revenues largely depend on custodial yields, which may be seen as a form of pricing power, meaning our interchange rates are not heavily influenced by the need to adjust rates or renegotiate with clients. This is a favorable aspect for us. If we were to experience a period of declining growth but ongoing inflation, that could be a positive scenario for our business. These are the considerations we keep in mind.

Very helpful. Thanks, guys.

Thank you, Anne.

And thank you. And our next question comes from Greg Peters from Raymond James. Your line is now open.

Hey, Greg.

Good afternoon. The three Amigos and El Guapo, I love the reference. I guess, in the spirit of that reference, I'd like to continue to focus on the plethora of net new HSAs. So you just commented on the market conditions, I was wondering if you could talk about the other drivers of net new HSAs, which would be retention and then what the competitors that you're in the market competing against how they're performing relative to, because it seems like you might be picking up market share?

Ted, you want to?

Sure, I'll start and then you jump in. Greg, I think I alluded to it briefly in my comments, we were definitely the beneficiary. We're the beneficiary of robust hiring by our clients in Q1, which really helped, and being the market leader per Devenir we probably have the biggest sales to catch that wind. And then, we've talked in the past about how one of the differentiators for HealthEquity is our distribution network, our tremendous partnerships with health plans, the health plan relationships we have acquired when we bought Further, and the tremendous work that the team has done to build closer partnerships with those distribution partners, health plans and others, we think gives us a durable advantage in driving HSAs and we've seen the results of that. So kudos to the teams that manage those relationships. And then, we've gotten smarter about where to focus and kind of how to fish where the fish are, and kudos to our sales leadership team for driving those efforts. And so we feel like we're spending time where we can win and that's, I alluded in my comments to the middle market, which is one place where we've really seen some growth. I don't have a ton to say about, Jon, maybe you do about competitors this early in the year. It's just a little bit hard for us to tell. Just like you we sort of leverage Devenir to get a sense of an analytical sense of how our competitors are doing. Anecdotally, our strong competitors remain our strong competitors.

Yes, I don't have much to add to that other than I would be remiss if I didn't throw a tiny bit of cold water in the sense that we don't expect that we're going to grow HSA sales for the year. While we don't give guidance on this topic, it's not within our range of expectations to grow them 38% for the full-year relative to what was a fantastic year last year. Hiring was clearly a big factor. We had some folks that were late breakers particularly from our partners as we got new partners up enrolling and kind of working some of the kinks out and so forth. So we would not want you to go crazy and we're not going to go crazy on projecting that number out to the full year, or the subsequent years, but it's a great way to start here.

Okay. Well, message delivered, we won't go crazy. The second question or the follow-up question would be, in your comments, I think Ted, you said it, but you were talking about the service revenue results or maybe I'm sorry, maybe it was Tyson, and you're talking about the service revenue was affected in part by a decrease in CDB service revenue. And I was wondering if you could unpack what happened with service revenue in the first quarter, not only from an absolute number perspective, but from a margin perspective.

Yes. Tyson, you want to do this one?

Yes, good question, Greg. One of the aspects to highlight is that HSA service revenue grew relative to the growth we previously discussed, which was expected. Regarding margins, I mentioned the margin headwind we experienced in Q1, which may slightly continue into Q2. This includes a year-on-year perspective, considering we had a strong year following January. Specifically addressing your question on CDB, this relates to our earlier discussion about revenue where COBRA uptake is lower due to fewer people being aware of the pool and less participation. Additionally, pricing for FSA and HRA may have declined slightly due to all the migrations we've undergone. These are the main reasons for the changes. Much of our integration process has now stabilized, allowing us to obtain better data and insights into the business. We are making significant progress in our approach to pricing and related areas.

Hey, I can't help myself, but just as a follow-up on that point. Tyson, you mentioned the second quarter guidance, you don't have the benefit from the legislation last year that was about $10 million of additional COBRA revenue, is that correct?

Yes, that's a good point. This was definitely the most significant quarter for us, and we've pointed out that the $10 million includes some revenue that might carry over into the next quarter. Additionally, there are considerable costs associated as well, so it's an important factor for everyone to consider when projecting our Q2 results.

Just I can't help myself, the margin on that $10 million. Is it consistent with the reported quarter average for the second quarter or was there something unusual on that?

I can probably take that. Go ahead, Ted.

Well, no, I was just going to say we haven't necessarily ever talked about that, I think, Jon, I don't know what you're going to say, but I don't necessarily have a comment on how to think about that.

That's what I was going to say. I’m trying to save his voice a little bit. Thanks, Greg.

Yes.

You have a plethora of questions.

Thank you. And our next question comes from George Hill from Deutsche Bank. Your line is now open.

I guess, I have to make the plethora of pinatas reference now. So, I guess, Jon, I guess, I just kind of start off with anything that you guys would start to call out is we're starting to see the earliest parts of the 2023 selling season. I guess, anything that should look different from the last two years or so given kind of how different the last two years looked?

I think the most significant point to mention is that we're seeing a continuation from last year. I would also like to get comments from Steve and Ted. The market segment that is between the largest enterprises and small businesses, which primarily comes from our partners, has shown strong performance. One contributing factor we noted last quarter is the increasing demand for HSAs among job seekers. People with HSAs are moving between companies, and many in the benefits space still perceive HSAs as being only usable with qualified plans or as lower-cost health plans. However, HSAs are very flexible benefits that can provide substantial advantages. This situation reminds me of the early years of 401(k) plans when people preferred pensions until they became comfortable with 401(k)s and found it unusual when pensions were not an option. This shift is a key trend I want to highlight as we progress through this year.

Yes, I mean, in addition to what Jon said, I think I've been very impressed with the Further team for example.

Yes, that's a good point.

We have known the team in Minnesota for a long time, probably about 15 years, and now we consider ourselves part of their team. We really admire the work they have accomplished over the years, especially with the help of my partners. We plan to spend some time with them to fully integrate our efforts. While we have met some of them via Zoom, we hope to get to know them better, maybe even at a baseball game. Witnessing the impressive work they've done has been noteworthy. Since we started HealthEquity nearly two decades ago, collaborating with health plans has been one of our main distribution channels. Initially, we believed we were the only ones who understood how to partner with health plans unless we owned one ourselves. However, we discovered that this team is highly skilled in this area. This addition has been a great asset to our organization, and we are excited about the growth ahead.

Yes. And Jon, maybe a quick follow-up. And this is going to be a little bit of a meandering follow-up. McKinsey had a survey out last week, all about employer-sponsored health benefits and one of the few data points in the report that kind of jumps out as unusual is over the last few years you've actually seen tremendous growth in customer satisfaction of HDHPs, of which HSAs play an important role. I guess the question I'm trying to get here was like, can you talk about the HSAs as the tip of the sphere as I think when you think of HDHPs, the things that are benefiting probably going to react with interact with the most, I would think would be their HSA and kind of your focus.

I think you've got a big piece of the answer.

Yes, it's about increasing engagement with employers that have already adopted the HDHP plan. What strategies can we implement to encourage more people within these employers to choose it? I believe that's a significant aspect.

Maybe just to say, first of all, I think you've got a big piece of the answer in that. Remember for most individuals, who are enrolled in an HSA qualified plan financially speaking, their primary interaction with that plan is the HSA, meaning to say they're not going to hit their deductible in any given year. But for people who haven't interacted, meaning there is a real opportunity to use the positive experience and help folks grow, and so maybe you can Ted talk about what we're doing there.

Yes, I’ll keep it short. I mentioned earlier the engagement capability we've developed, which is essentially about communication and education across multiple channels. Over the past couple of years, we've focused on helping employers enable their employees to understand this benefit. As Jon noted, back in the earlier days at former Canada, everyone was aware of it. We're still in the early stages. Whether people reach out to us via phone, app, or desktop, we provide ongoing guidance on the best actions to take, whether that's engaging with an HSA if they're not already, saving more if they haven't begun, or investing if they are already saving significantly. We've committed significant resources to this area because our clients want us to collaborate with them, and we're seeing positive results even though we recognize it’s still in the early phases. We see a significant opportunity to increase HSA participation and encourage more effective use of the accounts, especially with the many clients we have that offer them.

Okay. That wasn't a highly coherent question, but I appreciate the direction, which you guys took it. Thank you.

Thank you, sir.

Thank you. And our next question comes from Stephanie Davis from SVB Securities. Your line is now open.

Thank you for taking my question and congratulations on your strong performance in beating and raising expectations.

Thank you.

When I think about the health savings administrator acquisition, how should we think about that $1.3 billion of AUM getting layered in? Is there going to be a quick switch over, or is there a longer process to unlock these custodial revenues given their largest part of the assets revenue contribution?

Yes. It's important to note that the majority of HSAA assets, which we often refer to as HSA administrator assets, are invested, with around 80% to 90% in that category. What we appreciate about the capabilities of the HSA administration team is their expertise in the individual market, where, despite its smaller size, individuals tend to be more investment-focused compared to average employees in the group market. To answer your question directly, those assets were transferred in the first quarter and are included in the quarter-end totals and investments. Thanks to the excellent work of our team and our partners from HSAA and the intermediary investment custodians and managers, nearly all of those funds were successfully moved over in time. This transfers have created a growth source on the investment side, contributing to our income from investments and some service fee income.

So taking that one level further, what level custodial revenue contribution are you assuming from the acquisition this year? And could we see a little bit of an uptick as it gets layered into some of your newer contracts?

Yes. I guess, Stephanie, the answer, if I don't understand your question exactly. Maybe could you repeat it one more time, because maybe I'll get it the second time.

So, for the HSAA deal, what level of custodial revenue contribution are you assuming for the year? And are we assuming a tailwind then that could happen for next year to further add to this?

So, since the bulk of the revenue in HSAA is invested, meaning it's in mutual funds and the like, we've assumed — actually, what we've done there is, if I recall and it works out to about the same thing, but we've maintained all of HSA's pricing and looking at it to make sure that's right. And so and the result is that the custodial yields from those assets will be similar to our custodial yields overall, meaning, kind of, in that roughly 30 basis point neighborhood, and that's reflected in.

Okay, so it's not about getting any sort of better rates or something like that because.

No, no, no. There is a small amount, maybe around 100 million, that is in HSA cash, and the uptake of enhanced rates among that group is very solid, in the high 90% range. Our guidance does reflect that those assets have been deployed.

All right. Fantastic, thank you guys.

Thank you. Stephanie.

Thank you. And our next question comes from Glen Santangelo from Jefferies. Your line is now open.

Yeah, thanks for taking my questions. I just had a couple of quick rate questions as it relates to the guidance for the balance of the year. Obviously, there is no future rate increases in that guidance, is it still fair to say that there is about $1 billion in cash that are tied to short-term, sort of, variable rate, so we can think about do our own math in terms of the potential impact of any future rate increases on the guidance?

Yes.

That's right. Okay, perfect.

Yes.

And then maybe if I could just ask a little bit more of a difficult question, I know you don't want to look out to fiscal '24 at this point. But everybody's noticing right? Obviously, the five year and the 10-year treasuries are just above 3%, starting to see five year CD rates start to breach 3%. So could you without, sort of, speculating on which way rates go right? Could you just do a quick look back to January of 2020 and remind us where those placement rates are, so we can make an assumption that if rates did not move from right here and you were able to reinvest at these sort of placement rates like what sort of lift, we get on that third of the portfolio, so we can start to think about do our own assumptions and think about fiscal '24?

Yes. To consider this, our average placement rates for deposits from fiscal calendar 2020, which ended in January 2020, show that we reported an average custodial yield of about 249 basis points. Since this was an increase from the previous year, it indicated that placement rates at that time were higher. While we do not disclose individual placement rates, it should suggest that during that period, we were placing deposits above that average rate. Currently, we have the enhanced rates product, which, as its name suggests, provides a premium for our members and for us as well. Therefore, as conditions progress, you might anticipate a slight increase compared to what we observed at the end of calendar 2019. This offers a general idea of expectations, with our fiscal 2020 reported custodial yield serving as a reference point.

Okay, perfect. That's helpful.

You want to add anything to that, Tyson or correct me or whatever?

No, that was good.

Okay. And Jon, maybe I just wanted to quickly ask about the FSA business in terms of, are you seeing any normalization in terms of the seasonal spending patterns there? I know with some of the government regulation, kind of, changing, we saw some abnormal behavior; is that starting to normalize seasonally now?

Yes. This is an important question regarding getting the quarters right, and Tyson mentioned it in his prepared remarks. The first quarter FSA spending was pretty much what we expected, which was encouraging compared to the previous several quarters when it swung significantly higher or lower than anticipated. So far, the same is true for the second quarter. The answer is yes; we are seeing more normal spending per account for FSAs. Additionally, it’s important to highlight that as you model year-over-year for the second quarter, we won't have the benefit of the extra spending that occurred in the second quarter of fiscal '22. That spending was largely due to individuals nearing the end of the federal government's excess rollover period from the earlier pandemic emergency, which led to increased spending during that quarter. As a result, some of that spending was essentially pulled forward from the third quarter, but much of it was simply individuals using the funds available in their accounts. This is something to keep in mind on a quarter-to-quarter basis. Overall, we expect this year to be much more normal compared to the surge seen in the second quarter last year.

Okay, very helpful. Thank you.

Yes, sir.

Thanks, Glen.

Glen is the invisible source.

And thank you. And our next question comes from Stan Bernstein from Wells Fargo. Your line is now open.

Hey, Stan.

Hi. Thank you for taking my questions.

Hey, hello.

So maybe a first a clarification question on something you mentioned in the prepared remarks regarding the Further acquisition, I think you called out a potential source of synergies. Are there any dollar figures you're targeting there that you can quantify maybe time to recognize those savings?

We indicated at the time of the transaction that we expected to realize around $15 million in synergies, which would be gradual over the next few years. Our initial guidance for fiscal '23 and the updated guidance do not incorporate significant synergies at this point because most of these will come from the eventual integration of the Further and HealthEquity operating platforms. We are approaching this integration cautiously for two main reasons. Firstly, we want to ensure our health plan partner clients on the Further side are fully aware of our actions and can establish trust with us, allowing us to gather important input from them. Secondly, Further possesses valuable technical capabilities that are particularly beneficial as we aim to integrate our offerings more thoroughly into our partners' products. While there are other companies that provide white-label solutions, real value lies in engaging with consumers at relevant moments, which requires deeper product integration. We are making efforts to bring some of those capabilities over more swiftly, which we've started discussing regarding products. However, from a synergy standpoint, we do not expect to see significant impacts until fiscal '24 and into '25. Therefore, I've addressed both the scale and the timeline.

You did. You did. Thank you. And maybe one quick follow-up, maybe just revisiting the sales pipeline. So past couple of years obviously, the story has been about multi-product sales or vendor consolidation trends. Just more broadly it seems to me like benefit managers are becoming a bit more cost-sensitive. I'm just curious, is there something you're seeing on your end with your sales force, and to the extent that you are seeing? How are you navigating this any impact on the win rate would be helpful.

Sure. I'll share a few thoughts, and then Ted can chime in if he wishes. Firstly, I believe the first quarter brought us some positive news; our largest product is definitely HSA, which serves as our primary growth driver. Notably, most of HSA revenues do not come directly from fees paid by clients or members, which I think you're referring to. However, for those fees that do apply, when we look at the year-over-year figures, they remain about the same and have even increased slightly, marking a change from previous years. This is due to our ability to maintain pricing where suitable, as well as being more strategic in determining where to apply fees. This is an important point to note. Going further, our main strategy in addressing this situation is that the greatest cost savings for benefit managers come from the products themselves, not from our fees. It's about enhancing enrollment, increasing contributions, and optimizing the use of all the additional integrated services we provide, as our clients engage with us and our partners rather than opting for a more generic service offered by a company focusing solely on retirement or benefits and payroll processing. This tends to be the central theme. While we will remain competitive regarding fees, the key takeaway is that the main savings potential lies within the products themselves rather than in the fees charged. Ted, do you have anything to add?

Yes. The only thing I'm going to add is that through our health plan distribution, the cost of the services that we provide is a relatively modest component of the total cost of the decisions being made in choosing health care provider and not only that choosing a high-deductible health plan or finding ways to have more of your teammates choose that health plan is actually a cost savings opportunity, regardless of what the HSA fees are to Jon's point. So, I think that our distribution helps insulate us a little bit from cost pressures. And I would also say, well, yes, there is always going to be cost questions or cost pressures or competitive cost environment. I think that the benefit of offering the bundle that was our primary hypothesis when we bought WageWorks three years ago has kind of been proven out probably in excess of our expectations. People do want to consume multiple services and not only that even if some of the consuming multiple services the broker, the consultant, the health plan who selling it wants to send you multiple pieces of business even if each individual piece is not the whole bundle. And so I think that having the bundle may able to offer it in a thoughtful way is probably a trend stronger than a nickel or a dime here and there on a product price.

Got it. Thank you.

Thanks, Stan.

Thank you. And our next question comes from Sandy Draper from Guggenheim. Your line is now open.

Thank you very much and good afternoon. I tend to be slow in pressing star one, which means I arrive late in the queue. Most of my questions have already been asked, but I would like to seek clarification on one point. It seems that for the health savings administrators, the majority of those assets are directed more towards investments rather than cash. Is that the correct interpretation of what you were saying?

Yes, yes.

Okay. So considering the current inflationary environment, have you noticed any trends in cash balances and spending patterns? Specifically, are people who have been saving in their Health Savings Accounts now beginning to withdraw funds? I’m curious if there's an increase in withdrawals as individuals return to the doctor and face rising costs, like gas prices at $5 a gallon. Are you observing signs that while contributions are still being made, the withdrawals are increasing due to these inflationary pressures? I'm trying to understand how this might affect cash balances, especially with the potential boost from stronger interchange revenue. Thanks.

Yes. We haven't seen it yet, but your reasoning aligns with the patterns we observed in the first quarter. Traditionally, a recession leads to higher savings rates, while inflation tends to drive consumer spending. This seems counterintuitive but is consistent with what has been studied in economics. Therefore, it’s likely that your observations may hold true. As a result, we may not see the same healthy growth in average cash balances as last year, but we could see an increase in spending. Over the long term, we would prefer growth in cash balances. Without actual data, I can't provide a definitive answer, but your points are logical. Considering the relationship between investments, cash, balances, and interchange revenue is an important aspect when reflecting on the trends of the past few years.

Great, thanks. That's my question. Appreciate, Jon.

That's a good one. That's a good one for late in the queue.

Thank you. And our next question comes from Mark Marcon from Baird. Your line is now open.

Hey, Mark.

Good afternoon. It's good to talk to you. Could you provide more details about the enhanced yield product and the premium associated with it? Additionally, with the Fed reducing its quantitative easing measures, if you were to place funds now, what premium would you receive from your regular partners compared to the rates on jumbo three to five-year CDs?

Sure. Let me address those questions in reverse order. Regarding deposit rates, we previously mentioned that the premium over current average rates ranges from 75 basis points at the low end to 125 at the high end. It's important to note that the premium tends to increase when rates are rising and expectations are high, while it decreases when rates are falling or expectations suggest a decline. Currently, the spread for placing funds compared to average three- and five-year CDs is quite attractive. Historically, this situation resembles the mid-point of 2019, raising questions about how much of the Fed's actions are already reflected in current expectations. I’m not sure how to quantify that, as it’s a difficult question, but it illustrates the situation on the deposit side. About the enhanced rates product, it typically offers a 50 to 75 basis point premium over where we can place cash. We have only been managing this for almost a year, so it's still somewhat new. One key point to consider is that while banks may have adjusted their rates based on their expectations of the Fed's future actions, the effect of quantitative tightening—reducing the Fed's balance sheet—is still uncertain. We don’t fully understand its impact on treasury yields and corporate debt pricing because this is an unprecedented situation. Overall, as we've mentioned on this call, a significant amount of the earnings potential has been absent from the business for a year or two and is still missing this year compared to historical figures. As that earnings potential returns, it will not only boost profits but also provide us with additional investment opportunities, contributing positively to the bottom line.

Great. I have a couple of questions that are quite different from each other. First, how should we consider wage inflation in relation to your team, given that they have many opportunities? As we start preparing for fiscal '24, how should we approach the servicing costs you will incur? On the other hand, what are the benefits from the increased scale that you're gaining, particularly regarding the Health Savings associates acquisition, the integration of HSA assets, and the larger marketing presence you have?

You've run through the nice list. If your question is about how we view margin in the upcoming years, right?

Yes.

You've just outlined the positives and negatives, so I will summarize them in a different order that I believe is worth considering. Let's begin with the positives. Wages are going to rise, and we are doing our best to support our team. Our assumption is that this will not just be a temporary situation. Secondly, on the positive side, higher custodial yields will help us manage service fee pressures. I feel confident about our progress on the Health Savings Account side in the first quarter, but time will tell how this develops. Lastly, it's important to note that we've increased our capital expenditures, which includes stock compensation that will have an impact over the next few years. On the negative side, custodial yields, bundling and cross-selling, along with organic growth and M&A will provide the necessary scale. The reduction in integration expenses, although below EBITDA, still represents real cash flow. Additionally, we are beginning to see improvements in service delivery and tech-driven efficiencies from our investments, which we expect to continue. Whatever happens with commuter initiatives also plays a role. If given the opportunity to think about this over several years, I can remain somewhat optimistic, while recognizing that there are cautious perspectives about the current year. Overall, we believe there are substantial opportunities to grow margins in the business, as well as to keep investing to enhance our top line, which is encouraging.

That's great. And then just the last one, just with regards to Further, lots of things that you're doing, just how are you being perceived by the clients now within those Blue plans? Just in terms of partnering with being able to expand geographically to really leverage this. We're still in early days, but how are you thinking about that unfolding over the next two to three years?

I wish you were asking next quarter, because we having our Summit with these clients, which is clearly, we've been titled blueprints, I'm sure that not the first time that pun has been used, but it's in Chicago next month, which is the home of the Blueprint and that was invented technically, but it's true home Chicago School of Architects. But Steve you can maybe give us, since you probably participated more than any of the rest of us on this call in discussions with, particularly with the partners. Maybe you could talk that where you think we are.

Happy to, Mark. I think it is still pretty early, but generally, the feedback has been very positive. One of the key updates is from our team. We can't say Further anymore, but our collective team reported that we had a successful relationship with HealthEquity both before and after the acquisition. They mentioned that our collaboration worked out perfectly. They expressed that they appreciated what they received from Further and now value it even more. The point is, we now have a network of over 30 Blue plans that we're collaborating with. We have scale, and these teams work very well together, attending conferences and collaborating effectively.

I mean, it is blue.

I believe the essence of the matter is that we are learning how to collaborate effectively with these types of partners. Many individuals who use Further now work at HealthEquity and previously worked at Blues of Minnesota. They understand how to address their needs, and their model was designed to assist these Blue plans in growing. However, HealthEquity goes beyond just Blue plans; we have excellent integrated systems across the country owned by hospital organizations, and we can engage with them as well. It's not solely focused on Blue; it's about partnering with any clients and providing unique, sophisticated solutions that enable them to compete in the market. This is essentially the key point. Remember that we initially shared with one health plan back in 2003, and now we’ve exceeded 100; it’s quite an exciting development.

That's great, I’ll see you next quarter.

You got it.

Thank you. And our next question comes from Allen Lutz from Bank of America. Your line is now open.

Hi, Allen.

Hey, everyone. Thanks for taking the questions. I guess, on interchange that came in really strong in the quarter. I guess looking back in the model, kind of, pre-COVID, pre-WageWorks the first fiscal quarter is sort of the high watermark of the year for interchange, I guess, question one is that what you're thinking, that's sort of what's embedded in the guide for this year? And then point two, in that $42 million is that healthcare spending back to normal? Or is there any reason to be optimistic that healthcare spend increases over the course of the year.

So there's a lot in that question. I'm going to let Tyson catch his breadth and answer most of it. I'll answer the piece that I can easily; that's total revenue. Obviously, and there is an organic and inorganic component to that. And so, obviously, inorganic was helpful, and it's of course a mix of HSA and CDB, and yes, includes both health care and commuter. But Tyson, maybe you want to elaborate a little bit there. I'm not sure you missed the meeting, Jon, but I just mentioned that I wasn't going to add anything about commuter. I just want to briefly touch on the commuter aspect. It's quite small in relation to the reductions we've seen, but from an interchange standpoint, it's a minor part of that. It does indicate that more people are using it; I've noticed an increase in card swipes over the past three quarters. We're continuing to see growth in that area. The commuter side represents a high percentage but a very small dollar amount. I think everything else Jon mentioned is accurate.

Great. Thanks very much.

Thanks, Allen.

And thank you. And I would now like to turn the call back over to Jon Kessler for closing remarks.

I don’t have any closing remarks prepared. Let's view it as a success that some of you requested we be more concise in our responses, and we managed to save about 50 minutes. Let’s aim to maintain this approach. Wishing everyone a great day and a safe summer. This concludes today's conference call. Thank you for participating. You may now disconnect.