HealthEquity, Inc. (HQY) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome to the JPMorgan Healthcare Conference. My name is Anne Samuel, and I'm the Health Care Technology and Distribution Analyst here at JPMorgan. We're thrilled to have HealthEquity here with us today. With us are CEO, Jon Kessler; CFO, James Lucania; and Dr. Steve Neeleman. We're excited to have you all. I'm going to turn it over to Jon for presentation, and then we'll open up to Q&A.

All right. Let's do it. Can I just sit here and do the clicker? Fantastic. Okay. So, then I can just [ wonder ]. Probably not too far. So, Hi, everybody. Hello. Good afternoon. Thank you. You've made it through to the second day and the end of the second day. So you're like almost done, and here we are. So for -- I think most folks in this room -- I recognize quite a few faces, no HealthEquity. We are the largest manager of health savings in the United States. And as one does at the outset of this conference, the first thing that we do is we announce our expectations for end of year sales. To confuse everyone, we are a fiscal -- we are January 31 fiscal year-end. So this will be the end of fiscal '24. And '24 was a good sales year for us. We ended up growing our HSA business on an accounts basis by 9%, on an assets basis by 11%. And we sold 900,000 new accounts, down a little bit from last year, but we had all of these nice people churning through jobs last year, and we had 4 million new jobs created, only [ 2 ] this year. So not quite that level, but really, really good, really, really solid, well ahead of, I think, what people expected and the market responded accordingly on Monday when we announced that, and we appreciate that. If you think about this year's results, we don't have fully yet in hand what the market did, but the market was expected to add about 2 million accounts by the people who expect these things. And I don't expect anything else going on. And one of my directors -- are you on the comp committee? You're on the comp committee?

[ I am not yet ].

Good. No problem. Wait, not yet?

Not yet.

I think it was a threat. I am totally in control of the situation, Paul. But in any event, if you think about it, if the market added 2 million accounts, and we gross 700 million, let's say, we -- up 900, let's say, we end up netting 700 and change. The implication is that -- and kind of similar for assets. The implication is that we at HealthEquity -- and by we, I mostly mean they, I'm really the head of the overhead department. But the team -- it's funny because it's true -- Deputy Head of the overhead department on the left. At least he talks good. We captured about 1/3 of the market. And the reason I mentioned that here is -- a 1/3 of the market's growth. And the reason I mentioned that here is to talk about what the implication of that is for the value of our firm. Today, right, we generate about $1 billion in revenue in a $5 billion business, including the HSAs and the ancillary consumer-directed benefits, or CDBs, right, $3.5 billion, HSA revenue is $1 billion and $1.5 billion in CDB revenues, I think that adds up to [ $5 billion ]. And I think [ $1 billion ] divided by [ $5 billion ] is 20%, and guess what, we're 20% market share, 21%, something like that. And I only have a Master's degree in economics. Actually, I should be careful. It's technically in public policy economics, which is even more inventing stuff than regular economics. But I can do math. And I know that if you continue to win 30-plus percent share of the organic market, as we did this year, as we actually did last year also and as we did the year before, then eventually you're going to get to 30% market share. That's how it works. And we are in a market that continues to grow. It's growing by accounts, right, in the single-digits and by assets in the double-digits. And when you think about it from a revenue perspective, right, you have a market that's -- I think, a reasonable view is that this is a market that is, from a revenue perspective, growing in the high single-digits on an interest rate normalized, all those kind of things, basis that Jim is going to talk about. And so, if we can continue to do this, we're going to be in a market that's not $5 billion in revenue, but it's $10 billion in revenue within a decade, if not sooner. And we can be 30% of that, that would be good. That's a good story. And that's the story that you are invested in and that we are investing in and that we are focused on. And so, how are we going to keep doing that? Well, that's the next slide. Well, first of all, how do we do it? The answer is -- I don't really know. The answer is that -- is and has always been from the founding of the business on part of my partner in crime, Mr. Neeleman -- Dr. Neeleman, Dr., Mr. He's Dutch, could be Meisterburger. Burgermeister? One of those. In any event -- is -- the way we do this is that we have an incredible partnership ecosystem, and we have technology that more so than ever before helps us bring the value of that ecosystem to our members and also to bring the value of our members to that ecosystem. And when we're talking about -- on the provider side, we work with -- we're very -- I'm sorry, on the payer side, we focused very heavily on the Blue systems. And not only do we -- have we -- now we work with almost every Blue high mark, I don't know where you are. We're working on them. That's it. But remember -- some of you remember a few years ago, Anthem started selling its own product. Guess what, this year, Anthem was back selling some HealthEquity. Not bad. Our new partners this year sold 40,000 HSAs. I think it's like till the 40,000, I think it was really 45,000, but I'm not supposed to say that. And this is what we do that our competitors don't. Our competitors do some other things well, but this is why we have gained market share year after year after year after year after year, including this year. And what does this mean -- so that's all great. It sounds good, right. What does this mean for our members and clients? What it means is remarkable experience. And I said a few minutes ago that I think we're at a place where technology is allowing us to do more than ever before. And these are a few examples of this, right. We are using -- and I mean, a lot of companies are going to talk about AI or have AI as the header of the slide. It seems a little cheesy, right. But at least for us, it would be -- because like, okay, we're getting there. But what we're using AI and other things for is to do more -- to create more value with our partners. So frictionless example of that is, as we drive calls to chat and then ultimately drive calls to more automated formats of other kinds, we're bringing data in that allows us to resolve more at that point of chat, and not just to resolve more, but to bring more messaging that's valuable to our partners, right. Something that you could never do when you have 200 partners and every employer has a different ecosystem and so forth with a person. Like there's only so much they can digest on that little screen in front of them. But technology can. And this not only saves us money from a service perspective, it makes a better and more differentiated experience. This -- for those who are going to track out to our Investor Day shortly -- I know I'm not supposed to plug that because Jim is going to plug it. But one of the amazing things we're doing -- how many of you have ever been in a flexible spending account, one of our CDB products? Not -- it doesn't have to be from us. I didn't mean not you, but you. Like, how do you feel about the whole paper [ receipting ] thing?

Paid it.

Paid it, right? So we have a product that is now in market, uses AI, genuinely use Generative AI, not that machine learning stuff that people just want to call AI now, right. You can put your receipt in from Publix. I like Publix because I'm from Florida, right. And it's got the Clam Chowder on there, and it's got the sandwich. They make really good subs at Publix. And then it's got your bottle of [ night ] [indiscernible]. And the damn AI is smart. Not only does it know the difference, right, not only can it tell that off the receipt. It can explain to me -- even to me, why, right, -- why isn't the Clam Chowder eligible and why is the [ night ] [indiscernible] eligible. And like, if I happen to pick up some [ Kleenex ], why they're not eligible, right. It's incredible what this stuff can do. And this isn't like it's going to be available, whatever. We are rolling this out now. We have it with clients right now. We went 120 days from concept to deployment with our partners in Microsoft, really cool. This year, we launched -- this last year, we launched our health care chip card and our health care stacked chip card. That sounds like, okay, big deal. Lots of people have chip cards. There's nothing -- most banks do, of course. In our business, most people don't. And they certainly don't with stacks. And so, what's this going to mean ultimately? It's going to mean that for our customers, right, one, we're going to have -- this is ultimately going to be mobile, obviously. And it's going to mean that we can be more flexible at how we brand the card with our health care partners. It's going to mean that our end-of-year open enrollment experience where everyone talks about like, we have service expenses in the fourth quarter because people got to get those cards in their hands, and then they don't get the cards in the hands and they got to call, right. That's going to be part of -- that's going to all go away with instant issuance. And again, this isn't like some dream. This is something that we have already rolled into market this year. We'll complete the rollout of -- by the end of fiscal '25, but that is now almost to be current year. So the ecosystem we have, not only creates great experience right, it allows us to -- it propels all the ways we grow. New logos, right, meaning new employers where we did very well this year, growing our footprint of members within our employer base, and then, of course, helping our members grow balances, which makes this a more valuable firm and makes the experience more valuable for them. That's what we do. We try to do it well. And I think the numbers support that. And that's where my friend, Mr. Lucania, is going to talk.

Hi, everyone. I'm going to actually breeze through the first few slides here. These are just the summaries of our financial results over the last 3 years. And really, the key takeaway is that the numbers are going up and to the right for all the reasons that Jon illustrated there. And we're going to continue to move these numbers up and to the right. You've seen this slide before in the past, and we've rolled it forward another year. Really, the takeaway here is our custodial yield, that purple line in the middle. Those 2 gray lines are interest rates observable out in the marketplace. The purple line is what we earn by investing our customers' deposit -- our customers' HSA cash into instruments. We have 2 main ways that we invest. One is with our bank partners. That's the legacy way that we've invested client cash. The new way -- over the past few years -- and the rapidly growing way is what we call Enhanced Rates. It is a deposit with insurance providers. So this is an insurance [ wrapped ] similar to stable-value like you might see in your 401(k) plan. The benefit of that is much more stable returns, much less volatile returns. And interesting for you and for our members is higher average returns versus the deposit product. And -- so we've guided to about [ 2.45% ] our average yield, the purple line for this fiscal year, that ends at the end of this month, and we've guided a preliminary to 3% next year. You can see that gray bar, the 5-year -- the gray line at the top is 5-year treasuries. That is the benchmark rate for our new investments in Enhanced Rate product. So we will earn a spread on top of that 5-year treasury rate. And you can see that gray line is way above the purple line. So this is a – has been a multiyear tailwind, which increases our custodial revenue line. It will continue to be a tailwind. So we can flip to the next slide. This has got a lot of interest over the last couple of days for our meetings. This is a new disclosure for the company. We've previously just told you the total number. If you looked at our 3Q report, we said we had $14 billion of HSA cash. This is the same $14 billion of HSA cash. We've taken out $500 million of that HSA cash, which is sitting in floating rate short-term deposits. And this is how the rest of that cash is invested. This is the maturity schedule of that cash. So you see on the front end there, we've got about $2.2 billion that will be maturing over the end of this month and next fiscal year. That's yielding currently in [ 3s ]. So 5-year treasury is about close to [ $4 billion ] right now that will be reinvested at a favorable rate. But look at the next 2 bars there. This is our COVID era deposits. The reason that those rates are so low is because rates were 0 when they were deposited. So 1.4% and 1.6% coming off. And you can all take a view of where you think the 5-year treasury will be at that point in time. But suffice to say, it will be higher. And the reason those bars are higher are the results of our past M&A. So wage works deal is in that first fiscal 2026 bar. The further and [ fifth ] -- [ third ] [indiscernible] acquisitions are in that fiscal 2027 bar. That's why you'll see that lumpiness. And we are now investing about 80-plus percent of reinvestments as well as new cash into the Enhanced Rate product. So what that will effectively do is push these bars out to the right and should help us smooth that yield rate. But the purpose of this disclosure is really to get you guys so that -- we're at a health care conference, and we're talking about interest rates. We don't want to talk about interest rates. We want to talk about growth in HSA accounts. We want to talk about growth in HSA balances. That's going to drive the long-term value of the business, and this yield. What you really need to -- the one number you need to figure out is what do you believe is the long-term neutral 5-year treasury rate. And that number is -- certainly will drive a higher custodial yield than we have right now, but that's one number that we each have to figure out, and then we can all talk about market growth and account growth and asset growth. What's this going to mean? Obviously, a very high-margin business, the custodial revenue that drops down pretty significantly to EBITDA and then to cash flow. We've generated $470 million of operating cash flow over the last 3 years. We generated $166 million year-to-date for the first 3 quarters. You can now all more precisely model the future custodial revenue, and you will see that number continuing to expand. And finally, just an update on our capital structure. We ended the quarter with $334 million of cash. We are 1.6x levered. And over on the right, you see how we think of the waterfall of capital allocation. And think of the -- up high on the bar as high returns to shareholder, bottom of the bar, lower returns to shareholders. Clearly, organic growth, we view as the top driver of shareholder value. But portfolio M&A, the second bar, we are going to close the acquisition of BenefitWallet. It will be a multi-stage close. But by the end of our fiscal second quarter, we should have all of those accounts and assets on the platform. So Q3, you will see a true run rate quarter. That deal, of course, will push our leverage up a little bit. And we think of that bottom bar of debt reduction as the one that moves up and down this scale, right? As we are doing deals and pushing our leverage up, obviously, we want to reduce that debt, bring our leverage back down. We're happy with where we are now at 1.6x leverage. Paying down low interest rate debt is not a huge priority, but will be post that acquisition. And then, of course, the one bar that we haven't talked about is return of capital in the middle. Obviously, we're going to increase our leverage. It's not going to be a near-term event, but if we continue to execute on this plan and continue to generate that cash flow, don't have portfolio acquisitions -- if we don't have portfolio acquisition opportunities, we'll clearly start to build very large cash balances, and we'll have to talk about returning some of that capital to shareholders in the future. So here's the plug. Jon alluded to that -- alluded to that plug. February 22 at our headquarters in Draper, Utah, we're going to have our first Investor Day in [ 4 years ] -- 5 years. So we're going to talk a little bit more about the technology that Jon was discussing there. We can deep dive a little bit more into that maturity schedule as the market digests it a little bit, talk a little bit more about that enhanced rate transition. I think Steve is going to host a great dinner the night before the Investor Day. We're going to talk about what's going on in Washington. So some potential tailwinds to help grow this marketplace a little bit faster. And I think it's going to be a great event. I know many of you have already registered. But for those of you who have not, please do so, and that's the QR code that will bring you to the registration link. So I think with that, we will open it up for questions. Thanks.

Thanks so much for such a [ great ] presentation. If you do have a question, raise your hand. We'll be [indiscernible], it's a little bit hard to see over here, so I'll just try and keep an eye. But I'll start with the first one, and I'm going to take instructions and I'm not going to ask [indiscernible] to start. You have historically kind of talked about the market maturity of kind of 50 million to 60 million accounts. We're about halfway there right now. Can you talk about what the key catalysts or drivers are to continued penetration of the [ market ]?

Yes. I mean, I think we're at a place where if you look at the data, in the high end of the market, about 60% of firms offer HSAs. Though many of the firms that offer them, they're basically offering a product that is not at the level of the plan itself, priced terribly attractively. And I think that's -- they're sort of like, oh, I'll offer this to my guys in accounting, you want their tax savings, but I'll take some of it too by having effectively an expensive plan. And so there's still -- even within enterprise, there's still plenty of work to do. Steve was just saying, I won't mention the hospital. Can I mention the hospital? I guess I can. Can I? No. Probably not. But if we have a client that -- a partner of ours and a client that's in Massachusetts and is a general hospital that like has never offered HSAs and now they offer HSA, so they're still -- they employ 80,000 people. And so, there's still room for growth in that, but I think the bulk of the new logo growth is now occurring in the middle market and small group market. And then, at the individual level, it really is about, in my view, people understanding that all of the health plan offerings they have at this point -- and most employers have very similar profiles in terms of their likely out-of-pocket expenditures or -- in fact, actual out-of-pocket expenditures. Some of them are deductible, some are not. And we and the HR department is doing a better job of -- as better job as we can of articulating the value of the HSA plan. Once people are in the HSA plan, they're going to be in the HSA. And so, I think if you sort of take all that together, we see the next decade being one where we don't think that you're going to have geometric growth, but Algebra, is reasonable. And so if we grow 2 million accounts-ish to 2.5 million accounts a year within less than 10 years, we'll be at 55 million.

Dr. Neeleman, I don't want to spoil surprise for your dinner in February. But could you talk a little bit about what's going on in Washington? And is there anything that's going to catalyze growth?

Well, apparently, speaker, [ Johnson ], has a spending package in place, which is nice. No, I mean, they did pass out of committee some HSA expansion stuff in the fall. It's expensive. And so we've been working on different ways to try and bring that cost down. I think -- look, generally, there's a healthy appetite to get more people the benefits of HSAs. And one of the challenges is how do you pay for it. We've come up with, we think, some novel solutions, and we'll have some folks there on 22nd -- or is it 21st, 22nd? When is the dinner?

21st.

21st.

[ You'll ] only find out about the dinner if you register for the conference though. That's how it works.

21st. But we'll have some nice insight from people that are right there on the streets. And look, I think we're beyond the old kind of [ dictum ] that HSAs are bad for people, right. I mean, everyone understands the deductibles are challenging, but one quick -- couple of facts. The average family PPO deductible in this country is $2,900. The average HSA is higher than that, but not that much higher. It's like $4,500. And so, the antidote to all of these high deductibles and out-of-pocket costs are really the health savings account and people are starting to get that. And so I think legislators are generally more open to saying how can we tweak things a little bit to let people have the benefits of this immediate tax advantage spending device that also becomes a long-term savings advice as well, so, we're [indiscernible].

Looking forward to it. Jon, you talked about taking share and growing above the market. How much of that is just from market consolidation? Because the -- a large portion of the market is still very fragmented. So how much opportunity is there for consolidation?

Yes. I mean, if you look at the 3 largest players, ourselves, Optum and then [ Fido ], collectively 50% of the market, which means that there's another 50% out there. And I think that component will continue to consolidate. It is probably worth noting that -- even among the top 3 that on an organic basis, Optum has lost share. It just has done some M&A to get back to breakeven basically. I don't want to poke the bear, but that's the way it is. And so -- they're probably not in this room. And so, I do think that's a piece of the puzzle, but I also am pleased that we continue to win business from our best competitors. And the reason we're able to do that boils down to the fact, in my view, that, what we're offering and the way we've approached the business is about using the financial power of the HSA to drive what -- everything else that our clients and partners are trying to do, versus the HSA is just essentially another little account. It sort of works like an IRA with its own foibles. And if you buy our wall garden, then this is in the wall garden. I think it's just a different approach, and it's a better approach ultimately, not only for HealthEquity and our clients and partners, but ultimately, I think, for health care as a whole.

You always have great insight on the macro backdrop. And when we were sitting here this time last year, everyone had so much angst about employment. So curious, what were conversations like this year with employers during the selling season? And kind of how are you preparing for next year within your guidance in kind of -- around macro?

Yes. I mean the interesting factor this year has been that there's been a lot less macro talk over the course of the year. [ Though ] some, but there's been a lot of talk about the annualized increases in whether you conceptualize as premium or cost, just annualized increase in health care costs. Apparently, everyone else at this conference is doing too good a job. And so -- sorry -- nothing, it's too late in the day. But -- so a lot of the conversation this year has been about that. And I think maybe I'm going to throw to Steve a little bit since he's in these conversations too. I mean, when you talk to firms about what they're looking at this year and what they did look at this year and look at our enterprises that -- in particular, that ended up turning the knobs in the right direction on HSA, kind of talk a little about that.

Well, I think you're right. I mean, I think that when you look at the 6% or 8% or whatever percentage of premium increases based upon the size of the employer, smaller employers can hit more than that. The one question is, how do I shave off a couple of percentage points. And there's a few ways to do it. If they go to a higher deductible, obviously, the premium is going to be lower. But then if people have these HSAs, and that's where we've been doing a lot of this engagement stuff in there. And I think for the first time, Jon, in 20 years, most employers are now saying, yes, we will give you access to our whole population, you can message them, you can engage with them, you can teach them about the benefits of the HSA, because every dollar that goes into the HSA saves in payroll taxes, right? And people don't always -- it's not always intuitive that the money that goes into a 401(k), employer still has to pay payroll taxes. Money that goes into an HSA, the employer is saving 8% roughly on every dollar that goes into the health savings account. So there's multiple ways they can save not just by having a little bit higher deductible, a little lower premium, but then you also have people that are saving on taxes, and we do see better utilization for people that [ are in ] the health savings account. So yes, they're just saying, look, please engage with our people, help us not only get more people into these types of plans, but then teach them how to put more money into the account, right? Maybe even help them understand that once they get their match and their 401(k), they should consider now topping off their health savings account because that's going to save some [ bucks ] on taxes. And then, we're always a believer that if we can help people start to do things like do matching in the account, that's helpful. Or -- we've talked a lot about incentives. If they do certain preventative care, things you reward them by putting money in the HSA, some of our employers are doing that. We think we can do a better job at that because you're not only driving on health care cost through preventative care, but you're also increasing contributions to the HSA.

Jon, [ in fact ], some of the products you talked about before, particularly around like AI and your ability to kind of come through the receipts and things like that is really interesting. Are you leveraging that in your conversations with employers to kind of say like, hey, we have these capabilities and it's more user-friendly for your employees?