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Healthequity Inc
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Welcome to HealthEquity’s Fourth Quarter of Fiscal 2020 Earnings Conference Call. Please note that this event is being recorded. Please go ahead, Mr. Putnam.
Thank you, Olivia. Good afternoon. Welcome to HealthEquity’s fourth quarter fiscal year end 2020 earnings conference call. My name is Richard Putnam. I do Investor Relations here for HealthEquity. Joining me today is Jon Kessler, President and CEO; Dr. Steve Neeleman, Vice Chairman and Founder of the company; Darcy Mott, the company’s Executive Vice President and CFO; and Ted Bloomberg, our Chief Operating Officer.
Before I turn the call over to Jon, I have three important reminders to provide. First, a copy of today’s release posted earlier this afternoon is available for reference on our Investor Relations website at ir.healthequity.com. Second, our comments and responses to your question reflect management’s view as of today, March 16, 2020 only and will include forward-looking statements as defined by the SEC, which include predictions, expectations, estimates and 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 statements made here today. As a result, we caution you against placing undue reliance on these forward-looking statements. And we also encourage you to review the discussion of these factors and other risks that may affect our future results or market price of our stock detailed in the latest Annual Report on 10-K and subsequent Form 10-Qs or current 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. And third, during this call, we will reference certain non-GAAP financial measures, included in our press release where you can find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures.
I will now turn the call over to our CEO, Jon Kessler.
Thank you, Richard, and hello everyone and thank you for joining us on what we know is a busy and eventful day. Today, we are announcing strong results for HealthEquity’s fiscal year ended January 31, 2020, and we are providing guidance for 2021 with a focus on the strategic operational and financial impact on our business of the COVID-19 pandemic and of its economic fallout. After briefly touching on the results, I will offer comments on the strategic implications of the pandemic fallout, Ted will provide an update on WageWorks integration and our operational response to the pandemic, and Darcy will lead us through details of the FY ‘20 results and our outlook for FY ‘21.
Today, we reported record operating results, market share gains, and fulfillment of our promise to deliver a measure of immediate accretion from the WageWorks acquisition. FY ‘20 revenues of $532 million are up 85% year-over-year and adjusted EBITDA of $196 million is also a record. We previously announced FY ‘20 sales including record organic HSA openings, a market leading 5.3 million HSA members, $11.5 billion in HSA assets, and 12.8 million total accounts, including both HSAs and complementary consumer-directed benefits, or CDB participants at fiscal year end.
Earlier this month, Devenir Research published its calendar 2019 HSA market assessment quantifying HealthEquity’s market share gains. HealthEquity estimates that HSAs grew 13% market wide, while HealthEquity grew HSAs 15%, and that excludes those reported by Devenir in 2018 for the acquired WageWorks and 35% overall. Market-wide, Devenir estimates that HSA assets grew 23%, while HealthEquity assets grew 29% during divination [ph] period, and that again excludes those reported by Devenir in 2018 for the acquired WageWorks. If you do include those, it would be 49% overall. So, that’s a lot of numbers.
According to Devenir, Team Purple delivered faster organic HSA account growth versus the market. We delivered even more faster growth in HSA assets on an organic basis and even more added to its lead that we did with acquisition. At calendar year end, HealthEquity had number one market share of 19% by HSAs and was a close second by HSA assets at 16%. We promised you a tenth straight year of market share gain. Devenir has been doing this report for 10 years. And the team delivered that promise on an organic basis and then added significantly more with the WageWorks acquisition. From that acquisition, we also promised first year EPS accretion on a non-GAAP adjusted basis, and again the team delivered. Last June, just before announcing the definitive purchase agreement, we guided FY ‘20 non-GAAP adjusted EPS to between $1.35 and $1.42 per diluted share using our current definition of non-GAAP adjusted EPS. The acquisition was closed in August and today as Darcy will describe, we are delivering FY ‘20 non-GAAP adjusted EPS of $1.73 per share, which is 22% to 28% first year accretion versus our immediate pre-acquisition expectation. Darcy will discuss these results in a few minutes including the obligatory reconciliation to GAAP measures.
We believe HealthEquity is positioned for a vigorous response to the COVID-19 pandemic and its fallout on our industry. I would like to start with yields on custodial cash. In Q4, 23% of our revenue came from yield on custodial cash. That was down from 48% in our Q2, including cash in HSAs and CDB client held funds. Devenir reported that industry-wide, the comparable figure is 53% of revenue, and calendar year 2019 was attributable to net interest margin. So, we have become far more diverse and the main reason for this difference is our one partner total solution approach to HSAs and complementary consumer directed benefits.
The FY ‘21 guidance we provide today assumes the Federal Reserve Bank, which returned its benchmark rates to post 2008 crisis conditions yesterday maintains them there. The relatively modest implied impact of roughly 4% reduction in revenue from the midpoint of our prior guidance reflects the duration of fixed rate deposit agreements in our custodial cash program. As we have said many times, the program prioritizes relative stability over maximum return and from our perspective, that prioritization is now paying off. Reduction in interest expense on HealthEquity’s outstanding indebtedness significantly offset lower custodial revenue as Darcy will discuss.
What happens over time though if these conditions persist? For HealthEquity, data from well over a decade of custodial operation provide a sense of how yields on our custodial cash program change with interest rates banks offer typical customers on-time deposits. HealthEquity has typically earned on HSA cash, a 75 basis point to more than 125 basis point premium to average 3-year to 5-year jumbo CDs, 3 years to 5 years being the target duration for HSA cash under our custodial policy. This premium exists not by accident, but because our depository partnerships are not average. HealthEquity provides high visibility to future deposits and flexibility on duration needs and carries all of the non-interest expense of attracting, retaining, and managing HSA members, while our depository partners are those that are best able to make use of that visibility and flexibility from among well-capitalized, federally-insured institutions. In fact, the company’s lowest custodial cash yield for any fiscal year, 1.52% occurred during FY ‘15. National average jumbo CD rates were at or near their crisis year of lows during FY ‘15 with 3-year CDs averaging 0.51% and 5-year CDs averaging 0.80%. By contrast, HealthEquity yields on HSA cash have not maintained a consistent relationship to the gyrations of treasury yields over our history. Of course, the future doesn’t always look like the past, but HealthEquity’s experience during the last crisis as well as its lower exposure to rates versus competitors and versus its history should serve us well.
Today’s guidance reflects a commitment – also reflects a commitment to continue the integration process discussed over the last two quarters and to do so at full speed. We expect more growth opportunities as competitors with variable rate exposure with incomplete solutions or with outsourced platforms or insufficient scale find it more difficult to compete under these conditions. We expect greater attention to the proven cost savings to both employers and consumers from HSAs and complementary CDBs. Some portions of our solutions such as COBRA and commuter administration may see either increased or decreased utilization in the short-term. But in any event, we see this as an opportunity for long-term growth. Ted is going to walk through where we are in integration along with our efforts to deliver purple to our members, clients, partners, and to each other during the pandemic. Ted?
Thank you, John. Before discussing the progress on integration, I want to thank those responsible. Team purple has been nothing short of extraordinary providing remarkable service to our members, clients, and partners while embracing our integration goals all in very challenging times. Q4 is of course our busy season and this was the most successful one in recent memory. We couldn’t be more pleased with how our team members wrapped their arms around our partners, clients, and members by meeting all critical service levels. We are especially delighted to report that we met or exceeded service levels on the legacy WageWorks platforms that had not been achieved in years all while delivering customer satisfaction scores significantly higher than last year. These successes were made possible in large part by the service case project I discussed last earnings call and the incredible commitment that our team members have demonstrated. We can’t wait to see what the team is capable of as we make service delivery even more efficient and effective going forward.
The WageWorks integration remains on track. As of fiscal year end, we have achieved approximately $30 million of permanent run rate cost and revenue synergies, up from $15 million at the end of Q3 and we are on track to meet our $50 million commitment this fiscal year, one year ahead of schedule. Our investments to deliver a total solution on a unified platform also remain on track. As of fiscal ‘20 year end, we had spent $32 million on these investments with another planned $60 million in fiscal year ‘21. We will sunset 5 legacy platforms this fiscal year, one of which is already complete. We consider a platform to be sunset when there are no members actively served on the platform and all run-out services for members have been completed. Just this week, we will deploy the first phase of our unified experience as our first HSA asset migrations are completed. We are on track to complete the onshoring around the clock member service in Q2 of this year. We appreciate the understanding and patience the bulk of our clients, partners, and members are showing as we make these changes. They understand that they are getting an upgrade as well as a step closer to the total solution they want.
I won’t repeat a lot of what Bill said last month about our sales, marketing, and relationship management teams, nut let me simply reiterate that our pipeline is strong, our cross-sell efforts are delivering real impact and we have been able to use the integration as an opportunity to reactivate and strengthen distribution relationships. Of course, every client, partner, and prospect is prioritizing their response to the COVID-19 pandemic that will likely slow some decisions. The economic fallout may, as John suggested, ultimately create new opportunities or accelerate existing ones.
The team is committed to deliver on its integration, service, and sales goals even as we join many others in good citizenship to slow the spread of COVID-19. Per our business continuity plan, HealthEquity has transitioned to a work from home posture with offices opened for critical physical functions such as mail processing only. Team members are equipped to work at home for an extended period. We are monitoring critical service partners as they implement their business continuity plans. We have also taken steps to provide greater financial security to team members extending paid time off for those who may need it, paying for broadband and other work at home costs and expanding our helping hands program for anyone in extraordinary need. We have asked members, clients, and partners for patience, but more importantly for feedback on where we can improve as we all adjust to these circumstances.
In closing, we are confident the measures and progress I just described will help us achieve additional synergies and improvements to enhance our purple service and drive margin increases and we are working hard to realize them in this fiscal year to help offset the revenue decline that Jon discussed. However, our first priority is to maintain our service levels and be where our clients and partners need us to be.
I will now turn the call over to Darcy to review the financials and new guidance.
Thank you, Ted. I will review our fourth quarter GAAP and non-GAAP financial results. A reconciliation of our GAAP measures to the non-GAAP measures is found in today’s press release. Our fiscal fourth quarter financial results include the operations of WageWorks, which was acquired on August 30. The WageWorks acquisition diversifies our revenue growth opportunity reducing the overall impact of interest rates and rate variability on total revenue. In Q4, revenue grew overall and organically in each of our three categories. Service revenue grew to $122.2 million rising from 30% of revenue in the pre-WageWorks second quarter to 61% in the fourth quarter. This is primarily attributable to the increase in CDBs to $7.5 million, along with the 5.3 million HSAs that we now administered, including those that came from the acquisition of WageWorks.
Custodial revenue of $49.4 million in the fourth quarter increased 39% year-over-year attributable to growth in HSA assets and a higher year-over-year annualized interest rate of 2.41% on HSA assets custodied by HealthEquity during the quarter. Custodial share of total revenue declined to 25% from 50% in Q2. As John mentioned, 23% was attributable to custodial cash assets. Going forward, we have multiple paths to grow custodial revenue continuing to grow balances, transitioning all accounts to health equity custody, a process which as Ted mentioned is already underway and growing revenues from client held funds. The HSA asset table of today’s press release includes additional details that help you assess these opportunities. Interchange revenue grew 104% in the fourth quarter to $29.7 million driven by the increase in average total accounts. Our large base of total accounts offers multiple opportunities to grow interchange revenue going forward, including more favorable interchange shares with partners.
Gross profit grew to $113.7 million compared to $44 million in the prior year. Gross margin was 57% including the change in revenue mix resulting from the WageWorks acquisition. Operating expenses were $99.1 million or 49% of revenue, including amortization of acquired intangible assets and merger integration expenses which together represents a 15% of revenue. Income from operations was $14.5 million. We had a net loss for the fourth quarter of $200,000 or breakeven on a GAAP EPS basis. Our non-GAAP net income was $28 million compared to $19 million, a 47% increase. Non-GAAP net income per share grew to $0.39 compared to $0.30 per share last year. Adjusted EBITDA for the quarter increased 125% to $61.3 million and adjusted EBITDA margin was 30%. For the full fiscal year, revenue was $532 million resulting is gross profit of $325.9 million or a gross profit margin of 61%. Income from operations was $77 million and adjusted EBITDA was $196.5 million.
Turning to the balance sheet, as of January 31, 2020, we had $192 million of cash and cash equivalents with $1.22 billion of term A debt outstanding and no outstanding amounts drawn on our line of credit.
Turning to guidance for fiscal year 2021. Based on where we ended fiscal 2020 and the economic environment now expected for fiscal year 2021, we expect HealthEquity will generate revenue for fiscal 2021 in a range between $770 million and $790 million. We expect our non-GAAP net income to be between $124 million and $132 million, resulting in non-GAAP diluted net income per share between $1.70 and $1.81 per share. We expect HealthEquity’s adjusted EBITDA to between $245 million and $255 million for fiscal 2021.
Relative to our initial revenue guidance of $812 million to $820 million, today’s guidance incorporates a reduction of approximately $30 million to $40 million in expected revenues in FY ‘21 which is due to the deterioration of interest rate conditions and other uncertainties. We have replaced the depository contracts that expired last year and have placed new deposits for this year in fixed rate depository agreements. We do have a modest percentage of funds exposed to variable rates and current conditions leave us cautious with respect to yields on cash placements we will make throughout the year in connection with the transition of legacy WageWorks HSA assets to the HealthEquity platform.
Under present conditions, we expect the average yield on HealthEquity custodied HSA cash overall to decline in FY ‘21 compared to our prior guidance. Given the current rate environment, we now expect the yield on the HSA cash assets on the HealthEquity platform to be approximately 2.2% during FY ‘21. This reduction from our prior guide of 2.4% accounts for approximately $15 million of the revenue reduction. An additional $15 million reduction is the result of lower yields on client held funds, lower revenue anticipated from WageWorks HSA cash and lower HSA invested balances due to declines in asset value. However, the lower rate environment is also expected to reduce the amount of interest that we will pay on our outstanding debt. As was discussed in previous earnings calls, our variable rate debt is a natural hedge to rates on cash custodial cash assets. Assuming rates remain at current levels, we expect to pay approximately $20 million less in debt interest in FY ‘21 versus our prior assumptions.
Today’s guidance includes the effect of approximately $30 million of achieved run-rate synergies Ted discussed which will be fully realized in FY ‘21. Our non-GAAP diluted net income per share estimate is based on an estimated diluted weighted average shares outstanding of approximately 73 million shares for the year. The outlook for fiscal 2021 assumes a projected statutory income tax rate of approximately 25%. In connection with the assumed statutory tax rate, you will note that at the request of a number of our sell side analysts that cover HealthEquity and in an effort to simplify modeling of our projected tax rate, we have revised the method reconciling net income to non-GAAP net income and GAAP net income per share to non-GAAP net income per share. We have provided two reconciling tables in the press release. The first showing a reconciliation under the methods that we have used throughout this year and a second table that provides a reconciliation under the new prospective method.
As Ted mentioned, we continue to focus on margins and the realization of synergies from our combined operations. We are off to a good start for achieving the outlined synergies that Ted discussed earlier. Some of these synergies will be additive to both the top and bottom line for fiscal 2021 and beyond. 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 the 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 not excluded.
With that, I will turn the call back to Jon for some closing remarks.
Thanks, Darcy. So, I get a whole minute or two to be human here. I think our investors and public market participants generally might wonder how ready the team at every one of their portfolio companies is to meet the challenges that we all are facing now and certainly the opportunities that we have here at HealthEquity. And I stumbled on one data point that might be useful. One evening last week as many of our team members are assembling their workstations and work from home setups and taking their test calls, one of our permanent work-at-home member services specialists sent something out over our internal IM and I wanted to read it here. Dear office refugees, us homies just want you to know that we are 100% here for you. We sort of specialize in all, and she put the all in sarcastic quotation marks, that comes with being remote. So if you’re feeling the need, hop on over to homey chat any time of day or night. You’ll find remote experienced peers who are level experts and excited for the chance to help make things good as gravy. And then she signs that hashtag one partner. This little message went, if you’ll pardon that terrible pun, viral with inside HealthEquity under the subject line – under the following subject line which I think says it all. With teammates like this, we can’t fail. And with that, let’s open the call up to questions or maybe we won’t open it up to questions. Only if the operator comes back.
Olivia?
[Operator Instructions] And our first question is coming from the line of Anne Samuel with JPMorgan. Your line is open.
Hi, Anne.
Hi guys. Thanks for taking the question. Despite the lower revenue guidance, your EPS guidance is still really good for the year. And I was hoping maybe you could talk about where some of the incremental savings are coming from and maybe what you’re seeing in terms of shift from the synergies maybe out of revenue into expenses?
Sure. Darcy, do you want to begin speaking to that and we can – Ted or I can add?
Sure. So in the environment, we have kind of gone through everything within our operating plan, and we’ve tried to be understanding as we said that the revenue impact is approximately 4% of our total revenue as it was before and not that it doesn’t have an impact, but we have also taken a look at all of the things where we can actually make a difference. We don’t control what the interest rate environment does, but we can respond to it; and so, collectively as an organization, we’ve gone through every one of our anticipated efficiencies and synergies that we previously had been working on. So we already had a method in place to evaluate that, and we have taken a really good hard look at that and we think that we’ve made a commitment about how we could achieve some of that because we are very committed to looking at not only our top line but also our bottom line. And with that, maybe Ted or Jon can add some specifics about how we thought about this, but we do believe that overall throughout the entire organization that there are efficiencies to be derived.
Yes, Ted, anything to say and then I’ll finish up.
Sure. Just that I would support Darcy’s perspective. We have been planning efficiency management, cost management since the day we announced this acquisition, and so the good news is that we’ve been thinking about it really hard, and that allowed us to be ready when we needed to get as aggressive as possible within reason and balance being – managing cost as efficiently as possible, continuing to provide purple service. Our team has done an unbelievable job managing these integrations while finding efficiencies and delivering on those, and so I don’t think that there is any special sauce other than being ready and having a thought about it, you know. It wasn’t like the first time we thought about expense management was when the fed cut rates the first time. We’ve been thinking about it for quite some time.
And I think the last part of your question was about, really about the mix between revenue and expense within our synergy number. As you know, we are anxious for the point where we can stop talking about synergies and just talk about increasing efficiency, nonetheless since it’s the way things are. We laid out a $50 million synergy target originally to be achieved at the end of FY ‘22, accelerated that to the end of FY ‘21 and as you will recall, about $27 million of that was revenue and $23 million was expense. We are sticking with that $50 million number. Some of that revenue component probably comes down, but we will make it up on the expense side and much of that revenue will be just fine. As Ted said earlier, we’re much happier getting paid for something then that we’re doing ourselves than paying a third party to do it for us. So, there is some real savings there on the revenue side that will hang on just fine. So, there will be some modest shift in that number, but it won’t be terribly large.
That’s very helpful. Thanks. And then maybe just a follow-up, you talked about some of the moving pieces of the yield that’s driving some stability there, but assuming interest rates hold, is there a rule of thumb that we can think about in terms of what the out years would look like or the impact of how the current change in yields would flow through?
Yes, I tried to give some guidance on this topic in my opening remarks, and let me unpack it a little bit here; and again recognizing obviously we’re not providing out year guidance and all that kind of thing, but if you look at – we do have the luxury of having been specifically in our business in custodial operation for, I don’t know, 15 years now, and if you look at the data over our history, a couple of things becomes very clear, one which I mentioned earlier, which is our yields do not – by design, do not follow the gyrations of global fixed income markets, which are influenced by all kinds of things positively or negatively around global trade, currency et cetera, and we never designed the program to do that and it doesn’t. What they are highly correlated to as you might expect is the interest rates that banks pay on comparable duration large, which you can [indiscernible] to be $250,000, but nonetheless what I’d refer to as jumbo CDs. And if you look out over time, what’s tended to happen is that we have generated a premium to those of, as I said in the remarks between 75 and 125 basis points. If you look at the underlying behavior of the rates, which I think is key to answering your question, right obviously, there is a correlation these rates will drift down relative to where they were a month ago or are today, but they will likely drift down somewhat slowly, because well, they always do because in part that is the rates that banks are charging, because there are a lot of factors at play and banks continue to need money and so forth. And so, I guess our basic view is that a couple of useful guide points are what – as we said in the discussion where rates have been, where rates have been at the bottom of the last crisis, and in general where our premium has been to what banks are paying their more typical customers, and there is nothing we have seen in the past few weeks or frankly past few days that would lead us to a different conclusion than that.
Very helpful. Thanks for the color, guys.
Sure.
Next question is coming from the line of Greg Peters from Raymond James. Your line is now open.
Good afternoon. In your comments you said $20 million of lower debt expense. I am assuming that’s in your EPS guidance. Can you talk about your free cash flow for this year? And remember, Jon, you’ve previously said or suggested that you were going to use free cash flow to pay down debt. So, can you give us an update on the debt situation please?
Yes, Darcy you want to take this one and I will chime in.
Yes. So we expect to generate cash from operations. We have a few expenditures that we haven’t had in the past. One has been interest expense, which has been incorporated into our modeling. And additionally as we are making the transition of HSA assets from both the Mellon platform and the Webster platform, there will be some cash payments made to facilitate that going on and those have been incorporated into our cash flow, but we feel pretty good about our cash levels that we will maintain throughout the year and we will evaluate as our cash balances grow about paying off debt earlier in light of the current environment. The interest benefit that we get from lower interest rates on the debt helps cash flow by that $20 million and so we are very pleased with that also.
Yes. I mean just to be clear there, Greg, I think part of the gist of your question was, is the $20 million rate driven or is it based on repayment? The answer is it’s entirely rate driven. At some level, it was I guess I’d call it a happy accident, Darcy might call it brilliant planning, but there is a bit of a natural correlation there or hedge between our variable rate exposure on the cash that we manage and the borrowings of our own corporate money. So it’s not an accident that again looking at it from an EPS perspective or certainly free cash flow perspective that, that $20 million significantly offsets the $30 million that Darcy talked about on the other side of this. As to your question about repayment and generally, the situation of our debt, we have gone through and modeled out not only this year, but our thoughts with regard to the subsequent years and at this point, what we expect is that the – absent, let me put this way, as Darcy said a moment ago, absent an early repayment, our cash position at the end of the year would be more or less the same place it is now, perhaps little better and that it would grow in subsequent years. So we don’t really see a circumstance where – well, I guess I put it this way, so that does raise the question since we do have excess cash of whether we should take this opportunity to repay debt, it would be a little bit of a contrary move to what we see other people doing right now obviously. But if something we will talk with our board about and we will think about if it makes sense, we will do it, but whether we do so or not, I think the bottom line you should take from this is, is that there is – that we feel pretty good about where we are from the perspective of our debt.
Yes. I would add one other piece of that. That will probably be a later question anyway. So I may as well answer it right now. In the current rate environment, we do believe that there will be opportunities for additional portfolio acquisitions as rates generally go down, then those portfolios become a little bit more attractive in the marketplace. And so we want to still maintain the flexibility to be able to purchase those portfolios as they become available.
That was great. You nailed a couple of answers with my question. So my….
It was a four-part answer instead of a four-part question is what you are saying.
I want more of those please. So my second question or my follow-up I should say, so I am curious about how the C-19 virus has affected call center volume in the last couple of weeks and I am also curious about how you think it might affect the RFP and sales process this year as we think about results for year end fiscal ‘21?
Yes, Ted, why don’t you take this one?
Sure. So, I will endeavor to give you a multipart answer to that question. First, let me start with the member services organization. First off, just a huge thank you to both our member services leadership and our IT leadership. We have well over 80% of our team members working from home today. Today, being the first day of the work from home experience, which is just with no degradation in service, we met service levels on all critical platforms give or take in a day which is great to see in that first day. We haven’t seen an appreciable volume spike maybe a little bit in the COBRA arena, but I don’t think anything quite yet, COVID related, although we will certainly keep an eye on that and report back, but our most important concern operationally was just making sure we could continue to answer all the phone calls we get everyday, both ourselves and our outsource partners and everyone has answered the bell thus far today was a great service day in that regard. As it pertains to the RFP and sales process, we have been as you would expect monitoring this very closely. We keep tracking sales force kind of down to the meeting, did the meeting get rescheduled, did the meeting get postponed, did the meeting get canceled did the meeting go from face-to-face to virtual. And by far – the most of the sales meetings that we have scheduled are not getting postponed or canceled they are getting rescheduled to virtual. And so we consider that to be a positive sign. That doesn’t mean we expect that no one will delay these meetings or delay their decisions. I think everyone is trying to grapple with how COVID impacts them, but thus far the vast majority of any changes that Bill and his sales team have seen have just been to go from face-to-face to virtual which is what we hope to see.
Thank you.
Thanks, Craig.
Our next question is coming from the line of Jamie Stockton with Wells Fargo. Your line is open.
Yes, thanks for taking my questions. I guess maybe the first one just, I think Darcy, you kind of held out two buckets of headwind for revenue, one from yield on the cash that you are custodying and the other $15 million client held funds? Is that second bucket hitting the services line from a revenue standpoint instead of custodial?
No. So what I would characterize is the second bucket, the first one being kind of the legacy HealthEquity cash yields, the second one is kind of variable rates for both client held funds and the understanding that as we place new money from the transition, from the wage cash as it comes in, that those will be just at lower rates than what we have previously anticipated. But what we did do and we anticipated this we have been in contact with several of our depositories over the past few weeks. We have been in contact with our banking partners, etcetera. And we expected that the rate action would ultimately be taken whether they took it yesterday or they were going to take it on the 18, it’s what we expected to happen. And so as we have talked to people about what we expect those rigs to be, that’s what we have included into our forecast for yields and for custodial revenues. So we anticipated taking the Fed rate would go to a zero bound, which has an impact on the LIBOR rates that have some variability in our contracts. And so those we anticipated going to the zero bound and that they would remain there for the remainder of this year. And so we have incorporated that into the model.
Okay. And then maybe economic environment looks pretty choppy, can you just talk about the trade-off here of potentially higher unemployment as a headwind for the number of active accounts and maybe an increase in demand for COBRA services, how do you think about that?
Yes, I think that first sentence was probably the understatement of the week. It does look a little choppy. Look, we are fortunate I guess in this regard and that we have the benefit not only of the experience of HealthEquity, but also can reach back into the experience of WageWorks all the way back to its founding in 2000. And here is we take from that, in general, the business – first one point in general, the business is less cyclical than people think in both directions. And I think we have seen that certainly on the upside in recent years, but importantly also in the other direction that is to say I think it’s pretty steady. There are some things that do happen in down environments that are helpful to the business and it’s kind of funny, because the original investment that was made in WageWorks was made roughly the day of the market peak in March of 2000. And so you can imagine that the investors were asked do you regret this etcetera over the next couple of weeks and months and their answer was no, we think this is going to be something that’s a survivor and a fighter in this environment and it was. And the reason for that is as follows. First, actually something you didn’t mention which is in general, I mean these environments, people are more concerned about the cents and the dollars and we offer solutions that help employers and employees save money and at some level, it’s that simple. And that’s something that message resonates in this kind of environment. Second, as you mentioned – as you did mention there is the element of COBRA where you will see increased activity in all likelihood over the course of the coming months and we get some benefit from that, because COBRA is priced in part based on the actual activity that is acceptance of COBRA. And as I mentioned in an earlier call, this also kind of really what’s happened is really gotten us to think hard about everything that we can do for our members who are in that situation so that we can really serve them well whether it’s by offering COBRA or by directing them to other alternatives. So I think the short answer is that I think the business is mildly countercyclical, I don’t want to overstate that, but I think in general, there is that element to it. The thing that really does offset that, I think more so than the lack of employment therefore lack of accounts is just the rate at discussion. We have been having the fact that you don’t get obviously market increases that can help you out and one sort of a factor that I don’t know how it will turn out in this instance and in the 2008 period, there was a fairly dramatic increase in saving behavior and that was helpful to the business. Whether we will see a similar increase in this time around, I don’t know. Obviously, the crisis is much more related to something health than a financial thing and all that. So who knows, but that’s another variable that’s out there. So, that’s again a long way of saying sorry for the long answer, but that we think that there is a mild countercyclicality of the business that I don’t want to overstate, but it’s definitely there.
Okay. Thank you.
Thanks, Jamie.
Our next question is coming from the line of Robert Jones with Goldman Sachs. Your line is open.
Great. Thanks for the questions. I guess maybe just to pickup there around just the economic pullback and thinking if there is risk or precedence, you started touching on this a little bit just to the cash levels that are kept in HSAs, any historical reference on those being drawn down more rapidly than a typical period? And then I guess just thinking about new HSAs, any precedent from more challenging economic periods about just levels of money and savings that people are willing to put into HSAs that you would reference?
Yes, I mean, I guess I would – it’s hard because you don’t have the counterfactual, right, but all you have is the data, but in the aftermath of the 2008 crisis and certainly as it kind of seeped in that this was going to be around a while, what you saw more generally in the economy obviously was increased savings rates and that translated into what were perceived to be increased deposit rates into the HSAs. It’s interesting that the draw-downs really do not appear to have much if any correlation to broader economic activity with the important exception that obviously when people leave their job, if they are not on any HSA qualified plan, many will draw those funds down that kind of thing, but in general, the behavior you might expect and I think this is echoed in other areas of retirement, which would be to see massive draw-downs at this point. I think people are willing to take a pause on that and instead try to manage their expenses elsewhere rather than to drawdown funds that are there for their healthcare or what have you, but that’s been our experience obviously as I say, we don’t have the counterfactuals. So it’s not perfect, but in general, we don’t see that one as a material risk in the short or medium-term.
No, that’s fair. And then I guess maybe just a follow-up on the commuter benefit, I know it’s not a huge piece of the overall pie, but was there any risk – is there any risk around just reimbursement as in fact many employees are in fact not commuting and then thinking forward, is there any precedent or risk that you have seen for folks maybe not utilizing the commuter benefit as much given an economic pullback that we are seeing?
Yes, we have thought about this one and there is some and that’s a little bit reflected in the caution of our guidance that is there are some upsides maybe around COBRA. This could be a downside. I think the issues that we are concerned with here are the more practical ones and serving our customers well. So, we mail out a lot of trans-passes every month as well as load cards and so forth. And it’s fair to say that I think for the month of April and into May, transit agencies around the country are evaluating what their posture is going to be about people who want refunds for their monthly passes or that kind of thing and it’s our job as the most connected entities of those agencies to be able to explain those policies where people ask us get into the right place if we need to get them somewhere else and to make that happen. So at some level, some of those answers boil down to what the public agencies that are for the most part on the transit side are willing to do, but I expect that they will figure it out and we will be there to from our perspective to make sure that our members get to the right place, but I think it’s fair to say that in the short-term, there is something there. Do I think that people coming into Manhattan are permanently going to stop taking transit? I doubt it. It’s possible. If they do, they may have to park and I am not sure where they are going to park but they would be using our benefit there too. So, I feel like in the long-term, this is an excellent benefit and it will be fine, but yes, it’s certainly possible there will be some short-term blip there.
Great. Thanks so much.
Thanks, Rob.
Our next question is coming from the line of George Hill with Deutsche Bank. Your line is open.
Hey, George.
Yes. Hey, good afternoon, guys and thanks for taking the question. I will say it first, I am still trying to wrap my head around the – it’s a little bit choppy economically out there I will talk about that later. I guess just…
You know, Wells is a lot less fee dependent. There is fee use than other banks as we all read this morning in the Wall Street Journal, so that’s sitting pretty, going on. You are touching that one already.
No, I am not touching that one. So Jon, you said something to the effect of this weekend wasn’t the first time that you guys thought about the interest rate environment when you saw the Fed’s comments. And I guess my question is, it’s more of an anecdotal question like what can you do as you start thinking about what are going to be dramatic changes in the rate environment? I guess when do you start to put the plans into place, but I guess like the quantitative question I would ask is could you talk about what the duration of your rig contracts are right now and kind of how should we think about the timing of the visibility that you guys have. Like you have talked about spread, you have talked about thinking jumbo CD rates, kind of like, can you talk a little bit about the laddering of the rates contracts and stuff like that. Just how do we think about the visibility there?
Yes. So our rate contracts are laddered to a maximum of 5 years with a target average duration of between 3 and 5 years. And as we have said in the past, we tend to be in terms of average duration closer to the 3 than the 5, but with the longest durations at this point in the year, because we will have just struck these in the last few months for new cash and the like. So that kind of gives you a feel for how this sort of spools out over time consistent with Darcy’s comments. I think to your earlier question, we first of all, I want to say, this is something we always want to have some level of contingency for recognizing that our actual job is to run the business as efficiently as possible recognizing that there are factors we don’t control. And so we should try and run the business in such a way that we don’t try and run around adapting to them when it doesn’t make sense. So, we actually in this regard, I want to say as we got into late – certainly into mid-to-late February, oddly enough around the time of our initial guidance on the revenue side, this was definitely something we began thinking about. We admittedly I think we are not economic forecasters as you know, George, but we, I think internally had the view that it was possible that this would be worse than it appeared to be just looking at what the pictures were showing about economic activity in other countries that have been affected and the tendency of our Federal Reserve and so forth to jump in and try and save the day. So we’ve been thinking about that over the last number of weeks and as Ted said, kind of said okay, what does that imply about for lack of a better term the IRR on any investment we are making and if the answer is that it made a change, then we made a change and I think that’s how you want us to handle it rather than imagining oh you know there is some cost thing we would have gotten otherwise that we’re not getting now. So it’s the other way round, there were some cost savings we were just sort of hanging around with and so the effect of that is fairly modest, I mean obviously most of what we’re saying is there is going to be a rate reduction and that will affect the top line and it will have a little more modest effect on the bottom line, but most of it does flow through. I guess I’d say one other thing, which we haven’t said thus far and that is one thing that isn’t clear is how, how quickly others in our industry and so forth will respond to this in terms of the rates they pay the members. We – as I think you know George we define how we approach that issue in our custodial agreement with members. It is a formula. It’s based on what’s going on in the competitive market so that we don’t employ any discretion in that area, but it will affect the end result. We have conservatively I think assumed for these purposes that there is no change in what we pay our members and so forth whether that turns out to be the actual outcome is debatable but that seemed like an appropriate conservative assumption since we have no control over it.
That’s super helpful. I guess if I can have a quick follow-up. As we think about the competitive environment and the sales environment, I guess how long it sounds like you are not seeing necessarily an impact in selling, but one would think that churn is probably going to go down. I guess, how do you think about how long this kind of crisis drags on like when do things need to start to share signs of improvement for you guys to continue to have the ability to take market share?
I guess, I can join the thousands of other corporate executives who have said I am not an epidemiologist, because I am not. Sorry, I was just trying to add a little levity there, but – as I usually do. But I think what the answer to that question in both directions and I want to be clear that I think what Ted was trying to say is of course there will be some impact on sales. That will be true for every company. Just people will kind of be frozen in place to some extent, but we have been heartened by the fact that HR is one of those functions that can work virtually and how quickly our customers and prospects have transitioned to working in a virtual environment and focused our energy on both for our sales teams and to your point about churn, our account executive teams and our client service teams getting, those are the first people we wanted to get trained up on exactly how they would conduct themselves in a remote context, I mean, not just trained up on how the software works, but how to look your most professional in that environment. And I mean I was in a finalist meeting at the end of last week while I was trying to rescue college refugees from Boston and they are so broken up about their school be canceled by the way, it’s just they are just crying, it’s terrible. But that’s also sarcastic as I am sure anyone in the college and the kids knows. But in any event was at some level it’s a different version of how you use your time and how you present your best, but it maybe the case that sales executives can be just as more efficient in this environment than they are in the normal way of selling. It’s just different. And those who adapt to it well will do well and we are going to try and adapt to it well.
Okay. I appreciate the color. Thank you.
Sure.
Thanks, George.
And our next question is coming from the line of Donald Hooker with KeyBanc. Your line is open.
Hey, Don.
Great. Good afternoon. I think a conference call or two ago, you had referenced that there might be some intentional churn in your business, i.e., you might consider walking away from some unprofitable contracts with WageWorks were a couple of quarters in as you have gone. Have you pruned off anything in your – when you think about your revenue guidance, that’s what I was wondering in your revenue guide and is there any kind of pruning of some unprofitable businesses as well or what can you say about that?
Nothing has changed in that regard from our prior revenue guide. I mean, I think actually Ted can provide some good color on how we have approached this in different situations, because we have identified cases where we have unprofitable business and we are trying to do something about that. So, Ted, do you want to speak to some of that a little bit?
Sure. I think the headline is it is not yet a material revenue number where we are having these types of conversations, but nonetheless we are having them and they are – basically what we are doing is kind of a full throttle contract review whereas contracts come up we are taking the opportunity to ensure they are fair for both sides. And what we are finding is that where perhaps legacy wage bit off more than they could choose really around providing certain services and certain customizations, which were probably unnecessary and in any event unprofitable. And we are just having candid dialogs both with partners and with actual employers about whether or not we can continue to do those things and if so, if they really need them, would they be amenable to a price increase to support them. And those conversations while modest in number are going reasonably well because we are just being kind of candid and forthright about how we see the world and the fact that we want to stay partners with folks, but that we won’t be able to do it under the terms of the agreement and we have achieved some successes in renegotiating some of those deals. But I mean we are not talking a material revenue move relative to the size of the overall business. It’s just kind of – it’s really more of good hygiene and we have to continue to do it.
I mean I will say, Don, I think part of maybe where your question is going is to understand year-over-year growth that kind of thing. We did both in acquiring the company, in our initial guidance after we acquired it and then certainly in our most recent guidance we did assume some level of incremental attrition in the current year whether as a result of pruning or of just stuff happened for the moment, let’s put that aside and we have I think done pretty well thus far as we reported with the sales numbers, but that is part of our thinking.
And maybe one follow-up on the renewal cycles in your guidance, how much is sort of I think last call you were happy with some renewals that you had achieved?
Yes.
It sounds like these are like an ebb and flow, I assume ebb and flow, year-to-year renewals, I don’t know if one year is tougher than another. Like last year, you had a bunch of them intuiting here. Is there anything to think about in this upcoming year or that you are watching in terms of renewal cycle? Thank you. And that’s all I have. Thank you.
Yes, I will give a partial answer and then Ted if you would like to add to it or Steve – Steve participates in these two and he is available with us. We were happy, because we had a lot of, what’s the word, guinea pigs going through that python or whatever it is, last year of renewals and we were very happy about the result of the renewal process even we didn’t win them all, but particularly as the year went on, we won a lot of them. And we felt real good about that. So I think as the merry-go-round goes around again, it’s probably the case this year to an earlier question that there will be a little less work done on this and that will help us on the renewal side and we will certainly try to have it help us on the renewal side, but Ted, anything to really add to that?
Yes, I would just make two points. The first one is it’s a little early in the cycle, but we are monitoring very closely all of the RFPs that come in both from prospects and also from existing clients. And I think thus far, the ratio is reasonably favorable, but it’s early and second we understand that the bigger we get, the more territory we have to defend. And out of every 100 RFPs in the industry last year, maybe 17 of them were our clients and this year 19 would be or whatever the market share would dictate. And so we are allocating more resources to our enterprise clients precisely for that reason. We have doubled the size of our account executive team year-over-year to make sure that we build deep and mutually beneficial relationships with these clients to try to head RFPs off at the past or at least be ready to respond to them. But it is something that we watch very carefully and it’s a little early to tell, but thus far, we feel like we are on top of it, meaning there is no surprise RFPs or we found out after the client was gone that they took winter RFP. We feel like we have a pretty good handle on and where we said and so far so good, but it’s early.
Okay.
One other point here is every, especially as we get really accustomed to and as everyone understands the total solution we have to offer, I mean at some level almost every RFP is an opportunity for business expansion and we talked about – Bill talked about in February’s call some of what’s going on there. And so if you are a, let’s say, a commuter and FSA client now the farther we get down the road of total solution, one team, one company, one partner, one platform, the easier it is for us to offer you incremental services and to light those up in a way that a few of our competitors can do one, two or three or whatever but no one can do them at the scale that we can. And so I guess that’s just the way of saying we also – I think that Steve Lindsey and the team and Mary Lynn Yakel and team and the managers are strategic relationships with our larger employers. In particular as Larry focused on taking every one of these as an opportunity to increase the number of services we offer, which again in a frugal environment may really help us out. We can – I mean they really are genuinely scale advantages there that we can take advantage of and in part pass on to our clients.
Thank you.
Don, this is Steve. Just to add one comment. I am maybe the only person in America that actually had a business meeting today. To hit away from people, proper social vision team, one of our health line partners was way right here in Utah, they can offer a ski trip and all the ski resorts are closed. And so they asked if we wanted to have lunch with them. So that’s exactly what they said that we were talking about what they’re looking for and they said look, we want to extend our partnership with you. What do you know about individual coverage HRAs? I see HRAs increase as people say and had a nice discussion about them. So I think what I am thrilled about is I am out with our partners is that we can say yes so much more often and not just yes, we can do it, but yes, we do it in scale, which is pretty exciting.
Okay, thank you.
Our next question coming from the line of Mark Marcon with Baird, your line is open.
Alright, good afternoon and thanks for taking my questions. Just with regards to the slight economic volatility that we may end up experiencing, how are you thinking about the amount of increase in COBRA activity and how does that actually flow through in terms of when somebody goes on COBRA and what’s the incremental expense and how should we think about that? And then as it relates to the rate environment, how are you thinking about how your competitors may react with regards to increasing their monthly account fees?
Sure. On the COBRA point, let me say, you have sort of a part A and a part B. And part A was sort of when might that activity hit, etcetera and the answer really is, we don’t know, but I could mail answer syndrome you, but I won’t. The second part of your question regarding COBRA was sort of when someone goes on COBRA, how does it work? Depending on the arrangement, there are sort of two components to the revenue stream from COBRA. One is a general fee that’s typically on a per employee basis rather than per participant basis that sort of reflects the fact that we’re there, we are at the ready and there is a general – all businesses have a general amount of churn that occurs and so forth. So that doesn’t change very much, but what does change is the acceptance rate and there essentially the way that it works as I think you know is the law allows us to retain a portion, a small portion of the premiums to cover our expenses. So the more people that are it comes back to, you have to offer COBRA to everyone regardless of why they left your employment. So in a different environment, right, you might find that well if people were leaving for their next job and their next job at health insurance, you have to send them the same paperwork, but they don’t pick it. Here you may see more people take it and so that’s sort of the way the economics work. That’s when the economics can get better for you, but – and then as I said earlier, we’re going to continue to look at how we can offer more to these participants so that they have a number of options depending on where their needs are, but – so I don’t think anything would happen immediately in the first quarter or second quarter, but in terms of sort of the first quarter in terms of economics, but as things spool out, I think we might see some – obviously some of this will depend on legislation too and what Congress may mandate that employers do one way or the other. And then your second question, can you repeat the second one, I kind of remember it, but I don’t want to get it wrong.
Yes, just some of your competitors have been a little bit more aggressive with regards to the monthly account fees, thinking that they’re going to make it up in terms of rates and so I would think that some of them are upside down on that part of the equation and I’m wondering if you go back to your of ‘07 through ‘09 experience, what did you end up seeing with regards to how quickly they started adjusting and how did that competitive dynamic?
In the ‘08 – I mean that’s exactly what happened in that period where you did have people who were kind of upside down and either they exited the business or they adjusted and they did that in fairly short order and I have to believe that to some extent in sales processes and the like, that just as we are, that all of our competitors are looking at this issue right now and what I think is maybe the difference is that we are all looking at it from different perspectives depending on where we are in the industry. We, as I commented upfront, the way we see the marketplace going is that people want a total solution that includes the HSA and the complementary program just because you happen to be a custodian or you happen to be an investment firm or what have you doesn’t mean that they only want this from you that they want – that they only want that service. They want you to provide the solution looked at from their perspective and we are in a great position to do that and one of the happy accidents in this context is that looked at in the aggregate that solution is far less exposed to rate uncertainty and variability. So we think we have a lot of levers that we can pull and that’s reflected in the data. I mean if you look at as Devenir described, the average HSA generates more than 50% of its revenue from cash net interest margin. That number would actually be bigger if the accounting were the same way we do it, that is to say, and I’m not saying it has to be, but that is to say because we’re not a bank where you do gross accounting, but the point is that most HSAs generate most of their profits from net interest and to the extent that you are at a place where that’s sort of all you’re doing, in this kind of environment, you can’t make it up on volume. So I think the net of all that is to say, I think we and other competitors who are on the – but certainly, where we have we think the service that people want and that provides us some different – it provides us some sort of cushion for lack of a better term from rate variability we think we’ll be in good spot, but to answer your question, I think people are looking at it right now.
Great. Thanks a lot.
Our next question is coming from the line of Sandy Draper with SunTrust. Your line is open.
Thanks very much. A lot of my questions have been asked, but maybe one, I think it was about a year ago or maybe at the end of last year, you guys talked about a lot of new initiatives, investments in technology and other areas that because things were going well, you had a lot of margin you were going to, you were essentially more aggressively investing in the business. It sounded like what in the prepared comments that you certainly weren’t slowing down any on the integration, but are any of those projects being sort of put on the back burner right now as things that you can do to offset and sort of factor in the guidance how you’re holding may be EBITDA a little bit better even though there is a headwind. Are you delaying those things or are those things still pretty much going as planned and it’s really just the cost savings you get as you continue to integrate the businesses?
I think at the moment really the latter. The things that as an example, I mean, probably the prime example of this, as we said, we at the time, we are – we have made a considerable investment to assure ourselves that as the entire world including we move from kind of from on-prem data to cloud-based data right that we can develop in a scalable way and continue to get product to market fast and all that kind of stuff and that’s definitely a future facing investment we have tried to design what we do in a way that it generates return along the way and most of that return is not in interest rate etcetera, it’s in the speed to bring product to market and therefore lower development costs. So these changes haven’t really affected the IRR there at this point, but it is something we’ll look at. We’ll probably have a discussion on this topic for example at a board level just to think about what we’re doing. We’re certainly mindful of the fact that if we needed or if we felt that it was prudent to manage cash or something along those lines, then those are the kind of things we would do, because that, you’re effectively increasing cost of capital, but for the moment since the return on those projects is not based on changes in interest rate, there is no reason not to do them and we’ve always said that we are prepared to do things as long as they – we feel like they’re generating a positive return. We’re going to do things we generate the most positive return to you as investors and so, so that’s what we’re doing.
Great, that’s really helpful. And then just a quick one maybe either for you, Jon, I think you said or Darcy. I think you said you are pretty much assuming the $30 million reduction in revenue guidance from the last time you gave it you’re assuming it’s pretty much all flowing through to EBITDA. Was that correct?
Yes, Darcy you want to hit that one?
Yes, that’s correct. We gave a little bit broader range on there may be some uncertainties that we’ve included in the revenue, but generally speaking, that’s correct. The rate information we gave flows to the bottom line.
Okay, great. Thanks.
Our next question is coming from the line of Allen Lutz with Bank of America. Your line is open.
Hey, Allen.
Hey, thanks for taking the question. On the 4% reduction in revenue guidance, I guess what would need to happen in order to miss this new range? Would LIBOR and treasuries have to go below zero? Is there any way to just kind of frame what’s embedded in this updated range?
Yes, the short answer is yes. That is to say, we have not assumed negative rates mostly because very candidly we’re not exactly sure how to do so. I hate to put it that way, but in other words a negative rate is really a fee. What do you do with that and so and we’ve had a lot of conversations both with the folks who advise us from a policy perspective, but also with our bank partners and the like and certainly Jay Powell has said that he would be extremely reticent notwithstanding the situation to go to negative rates that he is not sure it’s a viable policy tool. So I mean that’s certainly something we have not assumed. Second, I guess I’d say and then that’s the biggest thing. I’ll stop there actually and there are some other things that could occur that would have modest impacts, but that’s about it. We’ve tried to be as conservative as we can recognizing that these are good times to be conservative.
Okay. And then for my follow-up, have you seen, I know it’s very, very early but have you seen any increased spending trends as it relates to the coronavirus or any shifting of assets from invested assets to cash or is there anything that you’re able to call out at this point?
Not really.
Great. Thanks.
Thank you. And I am showing no further questions at this time. I would like to turn the call back over to Mr. Jon Kessler for closing remarks.
Yes, thanks. Thanks everyone for being patient with us today. We certainly went a little long, but probably for good reason and we will continue to try and keep you informed as we know more, but I think kind of the message that you heard today is a little bit, obviously, we’re not ecstatic about the rate environment, nobody is, but it’s also true that as Ted said, we’ve got a team that’s performed extremely well and really performed extraordinarily over the last few months and is ready to do more and that’s what we are here to do to deliver for you. So thanks for your patience and we will keep at it.
Ladies and gentlemen, this concludes conference call today. Thank you for participation. You may all disconnect. Good day.