Richard Putnam - IR Jon Kessler - President and CEO Darcy Mott - CFO Brad Bennion - SVP of Products.

Polly Sung - Wells Fargo Stephanie Davis - JPMorgan Greg Peters - Raymond James Sandy Draper - SunTrust Robinson Mark Marcon - RW Baird Randy Reece - Avondale Partners Chris Howe - Barrington Research.

Welcome to the HealthEquity Second Quarter of Fiscal 2017 Earnings Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Richard Putnam, Investor Relations. Go ahead, Mr. Putnam..

Thank you, Ronia. Good afternoon, everyone. We welcome you to HealthEquity second quarter earnings conference call. My name is Richard Putnam, Investor Relations for HealthEquity.

With me today, we have Jon Kessler, our President and CEO; Darcy Mott, our Chief Financial Officer; and Brad Bennion, Senior Vice President of Products, participating with us on our call today. Before I turn the call over to Jon, I'd like to remind you of a couple of things.

First, a copy of today's earnings release and accompanying financial information can be accessed on our Investor Relations website at ir.healthequity.com.

Secondly, we remind those listening to our call today that today's discussion will include forward-looking statements, including predictions, expectations, estimates and other information that might be considered forward-looking.

Throughout today's discussion, we will present some important factors relating to our business, which could affect those forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from statements made today.

As a result, we caution you against placing undue reliance on these forward-looking statements.

We encourage you to review the discussion of these factors and other risks that may affect our future results or the market price of our stock detailed in our annual report on Form 10-K filed with the SEC on March 31, 2016, along with any subsequent periodic or current reports.

Finally, we are not obligating ourselves to revise or update these forward-looking statements in light of new information or future events. With those reminders out of the way, I'll turn the call over to Jon..

Thank you, Richard. And before we get fully into it, those of you who have participated in previous earnings calls will note that Richard's is a new voice to our team. Richard joined us over the summer, bringing with him more than 25 years of IR and finance experience.

Frode Jensen who previously participated in these calls as EVP and General Counsel announced his retirement over the summer, the first genuine HealthEquity retirement. He is gearing up to hit Utah's famous ski slopes full-time. Del Ladd has taken over the role of Executive Vice President and General Counsel.

Del has been HealthEquity's Deputy General Counsel for the past roughly six months and prior to that built up a distinguished record at Willkie Farr & Gallagher in New York, including a wealth of SEC and corporate experience.

So I'm hoping that others when they have the opportunity please join me in welcoming Richard Putnam and in congratulating both Del and Frode on their career changes. So with that, let me turn to our second quarter operating results.

Darcy, Brad Bennion and I will each share some perspective, and then we'll open up the phone lines to answer your questions.

HealthEquity continued to deliver strong positive results for fiscal '17, with substantial growth during Q2 in the four key metrics that drive our business, which are, revenue; adjusted EBITDA; HSA Members; and assets under management or AUM. Looking at each.

The pace of revenue growth remained very strong, with revenues up 45% year-over-year in the second quarter to $44.2 million.

Adjusted EBITDA not only outgrew revenue as margins widened but continued to accelerate its growth, increasing 66% year-over-year to set a record quarterly mark of $18.4 million or 42% of revenue compared to 36% of revenue in the prior year's second quarter.

Likewise, HSA Members grew 50% year-over-year to 2.3 million versus 45% year-over-year growth in the comparable period a year ago, and total AUM grew an even larger 60% year-over-year to more than 4.2 billion at the end of the quarter versus 47% year-over-year growth in the year ago period.

Over the last 12 months alone, HealthEquity has grown AUM by $1.6 billion. So the top line continued its rapid growth on a much larger base and profitability accelerated as did HSAs and AUM as the team continues to form the base of a strong profitable business for the long term. Turning to sales.

Consumers opened 84,998 new HealthEquity HSAs in the second quarter, which was up 21% year-over-year. HealthEquity members grew AUM by $115 million in Q2, up 31% year-over-year. Year-to-date, new HSA openings are up 27% and members have added 68% more AUM over the last six months than they did in the first six months of last year.

This sales growth is on top of the HSAs and AUM that the team successfully transitioned from M&T Bank's platform during the first quarter. So the sales team's production continues to grow and accelerate on a year-over-year basis, which speaks to HQY's market-leading competitive position.

Speaking of that, how are we doing versus market benchmarks? Devenir Research has published its midyear calendar 2016 market estimates and while there is a one-month offset to HealthEquity's midyear fiscal '17, we can make reasonable comparisons.

According to Devenir, HSAs and AUM market wide grew 25% and 22%, respectively, in the 12 months ended June 30. Pretty healthy. Thanks to strong organic growth and aided by modest portfolio acquisitions, however, HealthEquity grew HSAs twice as fast and grew AUM nearly three times as fast, 60% versus 22% for the industry.

Similarly, margins - I'm sorry, so we've had a great start to the year. Margins in our business are always tighter in the second half of the fiscal year, which Darcy will talk about in his remarks. We've got a lot of work to do but the HealthEquity team members are very enthusiastic about the rest of the year.

At our Investor Day in June, I introduced Brad Bennion, Senior Vice President of Product and Corporate Development. Now Brad is a ten-year veteran of HealthEquity, ten years this week, in fact.

He's done just about everything there is to do at the company but what Brad really does best is to listen, synthesizing what he hears into actionable insights for the company.

So I'd like to turn the call over to Brad for a few moments to share what he has been hearing from our partners, including those who participated in our Investor Day, who participated in our key partner Summit held in July and from our voice of customer research and ongoing work in the field.

Brad?.

Thank you, Jon. At our Investor Day, which you can still listen to on our website, we talked about HealthEquity's conviction that while only about 14% of working Americans have HSAs today, eventually, HSAs will become ubiquitous, as common as other retirement accounts like 401(k)s and IRAs.

They will be used not only for current health care spending but for long-term health care saving and retirement planning, resulting in higher asset balances. HSA assets under management could, under that market scenario, reach between $600 billion and $1 trillion at market maturity, versus $30 billion today according to Devenir.

When you spend your time listening to partners and consumers, as I do, you begin to understand why we are so convinced of this future. We invited a few of our partners to our Investor Day so that you could also hear of their enthusiasm.

Intermountain Healthcare explained how enrollment in HSA plans has grown year-after-year from 0 to 60% of their 37,000-person workforce. During that period of time, utilization of medical and prescriptions by employees has not increased. Intermountain employees are seeking more preventive and well care than ever before.

It is for this reason they expect to grow towards full replace that is, making all of their health plan offerings HSA-qualified plans in the future. Eastman Chemical, a $10 billion global chemical company, is already there.

They spoke at our Investor Day about the remarkable double benefit of lower spend today in growing employee health savings for retirement. We heard similar sentiments from participants in our key partner Summit in July. Suze Orman spoke from the consumer perspective powerfully about the key benefits of HSAs. First, lower insurance premiums.

Second, lower net deductibles taking into account employer contributions. And third, as she put it, the tax savings bonanza from contributing to an HSA as your first place to build savings. What we hear from partners and from members is what convinces us that our vision of every American family having an HSA will eventually be achieved.

We know our job is to lead the market as it grows, so we listen very carefully to the reasons customers partner with HealthEquity and their expectations of their HSA partner moving forward. Unlike our largest competitors, HealthEquity built and owns its platform in proprietary technology. This gives us a greater agility than our competitors.

We can act on what we hear, do it quickly and deliver value like no one else. At the Investor Day, two regional health plan partners, Optima and Blue Cross Blue Shield of Michigan shared how valuable this agility is. Both stated that they rely on our solution to help them compete in the marketplace.

They pointed out that the flexibility to be able to offer HealthEquity, as either a white label or a co-branded solution, helps them win and retain business.

Both of these partners appreciated the fact that HealthEquity has a full suite of health account solutions and that our platform helps expand and strengthen their product by integrating with their transparency, wellness, telemedicine and other consumer-facing solutions.

Let me give you a couple of examples of HealthEquity's ability to listen and act to meet the needs of an emerging market. The first example comes from an employer's focus group that reveals that the timing mismatch of health expenses versus HSA contributions was a barrier to pushing HSAs to employees living paycheck-to-paycheck.

So we created balance booster, which automatically accelerates employer contributions based on medical bills incurred and transmitted through HealthEquity's ecosystem.

A second example comes from network partners asking during strategic product review sessions, how can we further create a seamless member experience and make our mobile application even more relevant to our membership.

These strategic discussions presented an opportunity for us to leverage our open platform to not only allow key HSA data elements to display within the network partners' mobile application, but to seamlessly integrate via an app-to-app single sign on, allowing our network partners to take even greater advantage of the tremendous engagements created by our unique HSA experience.

As we have discussed, 26% of our members visit our platform every month, ultimately allowing our network partners to engage members in everything that we have to offer by meeting members where they are. This ability to respond to a fast-growing market is something that only a company that owns its own platform can do.

We know a key to our ongoing success is our ability to evolve HealthEquity's platform as our partners see more growth and complexity in their HSA-qualified population. The key to that evolution is an ongoing close and listening relationship with our partners and members.

I will now turn the time over to Darcy to review our financial numbers for the quarter..

First, we have historically and we will continue to operate tiered pricing approach and lower services per HSA for more volume of HSAs from our network partners, particularly when they come to us with higher balances.

This tiered pricing approach to service fees is strategic to our business growth, and based upon our operating results it is working well. Second, service revenue include revenue from flexible spending and Health Reimbursement Arrangements, what we call RAs, which are complementary to, but are not growing as rapidly as our HSAs.

Our experience is in line with the industry data, showing HSAs growing in popularity while RAs are more or less flat. And third, acquired HSA portfolios typically have lower service revenues per HSA and contain a minimal amount or minimal RAs. Custodial revenue was $14.8 million for the second quarter, representing an increase of 64% year-over-year.

The driving factor for this growth was a 60% growth in total - in ending total AUM. The growth in total AUM was fueled through strong organic growth along with acquisitions, HSA rollovers and AUM transfers during the first half of fiscal '17.

Our annualized interest yield on cash AUM was 1.58% in the second quarter of fiscal 2017 compared to 1.56% in the prior year. Interchange revenue for the second quarter was $10.6 million, representing an increase of 56% year-over-year.

Interchange revenue also benefited from the 50% year-over-year growth in average HSAs in the quarter compared to the second quarter last year. Gross profit for the second quarter was $28.6 million compared to $18.6 million in the prior year for a gross margin of 65% in the quarter versus 61% in the prior year.

This is directly attributable to two factors. First, as we have discussed before, rising gross margins as a result of increasing custodial and interchange revenue from accounts we already have, a happy outcome that will only become more important as accounts mature and their balances grow.

Second, our service delivery organization did an outstanding job during the quarter of taking advantage of the increased scale that account growth provides HealthEquity, while continuing to deliver the high-quality Purple service for which HealthEquity is known. We don't typically spend a lot of time on these calls talking about G&A expense.

However, G&A increased by $1 million or 21% sequentially from Q1 to Q2. This was driven by a mix of onetime and recurring expenses as we continue to provision the company's risk management compliance program and legal function.

We believe it is strategically important for HealthEquity to understand and effectively manage challenges and identify opportunities resulting from the regulatory environment. The recent adoption by the Department of Labor of an expanded definition of a fiduciary in the context of investment buys to include HSAs is one example.

We have started to make expenditures that will help us fully comply with both the letter and spirit of the DOL's new rule and we believe the result is a better offering and lower cost investing for HealthEquity members.

Income from operations was $12.7 million in the second quarter, an increase of 70% year-over-year, and generated an operating margin of 29% compared to 25% in the prior year. We generated net income of $8.2 million for the second quarter of fiscal 2017 compared to $4.4 million in the prior year.

Our GAAP diluted EPS for the second quarter of 2017 was $0.14 per share compared to $0.08 in the prior year. Our non-GAAP adjusted EBITDA for the quarter increased 66% to $18.4 million compared to $11.1 million in the prior year. Adjusted EBITDA margin for the quarter was 42% compared to 36% last year.

Combining our first and second quarters produced robust growth for the first six months of FY '17. I won't take time to go into the same details that I did for the second quarter results but I would like to call out a couple of highlights. First half revenue is up 46% compared to last year. Gross profit is up 54%.

Operating profit grew by 68% in the first half of FY '17 and operating margins were 29% compared to 26% last year. Turning to the balance sheet. As of July 31, 2016, we had $149.5 million of cash, cash equivalents and marketable securities, with no outstanding debt.

We generated $15.5 million from operating cash flow during the first six months of FY '17. I now want to comment on our outlook for the full fiscal year 2017. We have previously provided guidance on revenue, adjusted EBITDA and non-GAAP adjusted EPS.

In order to more fully align ourselves with SEC guidelines, at this time and going forward we will provide guidance on revenue, net income, GAAP EPS and adjusted EBITDA. There are three factors that I want to emphasize that we include in our analysis for FY 2017 guidance.

One, it is still early, of course, and I would remind you that 70% to 75% of annual account openings historically occur in the fiscal second half, with the majority happening in fiscal Q4 with the start of many asset plan years. Accordingly, our margins in the second half of the year are usually lower than the first half of the year.

We experience seasonality in our cost of services in our third and fourth fiscal quarters as we gear up to on-board these new customers. We also accrue sales commissions as new accounts are opened.

In fiscal 2016, for example, we recorded approximately $5.9 million in additional service costs and $2.2 million in additional sales and marketing expense in the second half as compared to the first half of the year. A comparable phenomenon will occur this year, with the magnitude influenced by the results of the selling season currently underway.

Second, interchange revenue declined last year from Q2 to Q3 as HSA Members met their deductibles and spent less. We anticipate that we will see a similar pattern this year with a rebound in Q4. And as I mentioned earlier, we are also increasing investments in G&A to ensure compliance with regulatory requirements.

Based on those three factors and our year-to-date results that we have reported today, we now expect full year revenue between $174 million to $178 million, up from our prior guidance of $173 million to $177 million; net income between $23 million and $25 million; GAAP diluted EPS between $0.38 and $0.42 per share, resulting in adjusted EBITDA between $59 million and $62 million, up from our prior guidance of $58 million to $60 million.

Our GAAP diluted EPS estimate is based on an estimated diluted weighted average shares outstanding of 60 million shares for the year. The outlook for the full fiscal year 2017 assumes a projected effective income tax rate of approximately 36%. With that, I'll turn the call back over to Jon for some closing remarks..

Thank you, Mr. Mott.

While this call focuses primarily on looking backwards, this is the time of year right now when our team in the field, which includes our sales leaders, our implementation specialists, our relationship managers, our open enrollment specialists, are really racking up the road miles to win new relationships, expand existing partnerships and to make sure that HealthEquity delivers everything [indiscernible].

And so I'd like to take a moment here to say thank you to all of these team members as well as to the team members from our partners for this effort and to their families for the support during this time of year.

If the second half of the year is like the first, all that work will have been well worth it, giving more Americans the ability to build health savings. And with that, operator, let's open it up for questions..

[Operator Instructions] And our first question comes from the line of Peter Costa from Wells Fargo..

This is Polly Sung in behalf of Peter. I was hoping to first begin a little bit or get a better understanding of why you are changing your guidance basis to now include stock-based compensation..

Yes, Polly, thank you. There's been a lot of press about the fact that the SEC has requested people to give equal or more prominence to GAAP measurements than they do to non-GAAP measurements.

And in fact, we did have our 10-K and our first quarter reviewed by the SEC and we got a comment that I think it's out there publicly available now, and one of the comments they had was not only to give equal prominence to historical, the reconciliation between GAAP and non-GAAP measures, but also to do that in our business outlook.

And so as we looked at that and evaluated, that we felt like the only difference within our non-GAAP earnings and our GAAP earnings was the stock comp.

And since we provided the stock comp as a reconciliation item between our net income and our adjusted EBITDA in this reconciliation, we felt that we would give you enough visibility into making that calculation and that we would just conform to the SEC's request and then it may be easier just to go with GAAP net income, GAAP EPS, and then we'll still provide adjusted EBITDA as our only non-GAAP measure..

And just to be clear, you plan on providing the breakout for stock-based compensation going forward?.

Exactly. I think there's a - I'm pretty sure there's a reconciliation in the earnings release itself and we will continue to provide that breakout of that stock-based compensation..

Okay. And then I have a question, I was hoping to dig a little bit deeper in your revenue per HSA account. I know the decline year-over-year, a lot of it is driven by service revenue, and you went through the three items that really drove that decline.

But for this quarter, a decline year-over-year as well sequentially, I was hoping you could provide some color as to how much of it is driven by acquisitions versus the tiered pricing approach, and then the inclusion of RA accounts in that calculation..

Yes. In our first quarter, we talked about, I think, that the year-over-year decline was maybe 14%, I think it's 15%, and at the time we said that we expected that a trend to continue through the rest of this year because of the base that we have and the accounts that are already in with their pricing in place.

The components of that, we haven't gotten into a great deal of detail of what the different breakouts of that are, going too far with that kind of gets into our RA component and we're not ready to give pricing on that. But the most significant item is the tiered pricing approach.

The second most important aspect of that would be the RA component of the pricing model..

Okay. So acquisitions really did not play as big of a....

They do which is....

Yes, they would probably be third..

Yes, third. I think what Darcy's trying to do is - the reason we don't break this out is it's a practical matter, if we were to do so, we're giving our competitors our fees. And our competitors aren't lining up to do that.

So that's why we don't break it out but I think what Darcy is trying to say and trying to get to the gist of your question, if you kind of look at the three factors and you have them exactly right, it's - the biggest one is around tiered pricing arrangements, et cetera, and then the second biggest one is around RA and the third biggest one is the effect of the acquisition..

And then really, my last question, I'll let someone else speak, is your interchange revenue per HSA account is down from first quarter. I know that was high in the first quarter but still a pretty high level versus what we were expecting.

Should we think of that as a new normal or could it come down even more dramatically in Q3 to back to where, let's say, it was last year?.

No. So last year, I think we stated that our first quarter is our - is always our highest spend quarter for HSAs. And it's a little bit counterintuitive to the FSA mentality. In an HSA, because deductibles start over at the beginning of the planned year on January 1, everybody is spending in that first quarter.

As people reach their deductibles and then they go - so they're then ensured at that point and they stop spending on their HSAs, then it starts to diminish further in the second quarter. And last year, we saw a particular decrease from Q2 to Q3 in spend, in total spend from - on the HSA platform particularly.

And so then what happens in Q4 is it kind of returns to maybe a normal level of Q3 but what you'll end up picking up is all of the new accounts that you get in Q4 pick up the total spend level so that's why the interchange revenue pops back up in Q4..

But last year in Q3 the decline that we saw, would you say that was abnormal?.

At the time, we thought it was abnormal because we hadn't seen the level of that occur in the prior year. And so we were - I think we stated, we are not ready to say this is a trend. We're now just being cautious that since we saw it last year, we're being cautious about that spend level in Q3..

And if you kind of delve deeper into it, Polly, I mean, what's happening here is that as you get into the, particularly, into our fiscal third quarter, there are two factors there, some seasonal factors in health care spending, broadly in terms of when, you think about it, sort of the third quarter that some of the stuff that actually happened over the summer hits and the summer is seasonally low in terms of actual incurrence of spend.

So that's a factor, and then as Darcy said you obviously have people who start to hit their deductibles or if they have an HSA, they run out. So I guess if I return to your original question which is, is Q2 the new normal, I think Darcy's prepared remarks made clear that we are not assuming Q2 as the new normal..

And our next question comes from the line of Stephanie Davis from JPMorgan. Your line is now open..

You've seen really strong top line growth over the past few quarters in spite of the decline in your monthly account maintenance fees.

I know you've addressed this a bit, but is there a minimum level you would target for per account fee revenue? Or is there like a terminal situation where the revenue stream could go to zero and you'll focus more on the custodial and the interchange?.

Well, it's a great question. Maybe a way to answer this is to step back and understand where these fees each come from and it really, I think, shines a light on our strategy here.

The service fee bucket includes a number of things, but obviously its biggest piece is our monthly service fees that are pretty much paid by employers or by members themselves.

And the other two buckets, that is interchange revenue and custodial revenue, are effectively paid in one form or another, either by third parties or are paid sort of indirectly.

And so our view is that strategically, it's important for us to be kind of on - the pushing the envelope as it were on service fees, particularly since, at least it's our view that we, as an organization, have been doing, I suppose, as well as and probably in some cases better than the rest of our industry in driving and capturing for ourselves the other two components.

So the first point I'd make in response to your question is you are right to kind of cast this as a strategic effort on our part that is in part responsible for the growth we've seen. That having been said now this gets to the does it go to zero point. We've deployed this strategically; at least we think we have.

And so it's not the case that we're out there saying, hey, anyone can have an HSA for free or for $1 or whatever.

What is the case is that when we look at our partnerships, our network partnerships, meaning our large employer health plan relationships, what we try to do is to use tiered pricing structures as an inducement to have our network partners really work with us to drive both HSA growth and AUM growth, which obviously is the goal at the end of the day.

And it's working, and to some extent, what you see here is evidence that it is working. What we're not going to do is simply say, well, it doesn't matter who you are the fee is the same, because that doesn't really make sense.

It makes sense for us to deploy that as a resource that we can use to induce our best partners to do what they do well and what they can do well, which is to help us help members build their health savings. So that's kind of the way we look at it. I don't - we don't really see this kind of going to zero.

I mean, if I sort of had to - if I were on a witness stand, I'd probably point out things like the fact that HSA account administrators still get paid flat fees at the beginning of their - on a per month basis and their balances are quite a lot higher than ours.

But even if that weren't the case, I guess my basic view is what you're seeing here is the result of a strategy and the evidence that the strategy is on plan is that while we are executing it, we are still growing our margins at the bottom line or EBITDA or what have you or gross margin by substantial amounts..

And this is Darcy, let me just add one thought to that. Back in the day when the federate was at 5% or more, you'd have a lot of - our competitors who are offering HSAs with no service revenue or no service fee.

And over time, as interest rates came down, they felt like, one, servicing these accounts that are not just your normal savings accounts, they actually have transactions in the month in and month out, that they actually do cost money to service, and so not all HSAs are created equal.

And we will choose to differentiate based on the behavior of the HSA itself. If they have a significant balance, we're going to offer a lower account fee. But an account that has - spends all their money, yes, we get interchange out of it, but if they have no custodial AUM, then servicing that account and taking care of it is more costly.

So we will continue to differentiate..

And our next question comes from the line of Greg Peters from Raymond James..

I have to say I like the sound of Frode's new job. I hope he has a big HSA balance to offset the risks associated with becoming a full-time skier..

He is in retirement, so he can't - I don't think he's going to be on Medicare and he can't yet contribute but we are working on that. So we are hoping that he won't spend it down very quickly and he's a wise investor, so I don't think it will be the first thing he gets at..

Well, and certainly with your growth, it's not a reportable event, that's for sure, if he starts drawing down on his balances, so..

We do miss the facial expressions he makes at your questions, not just yours, Greg, but everyone's. Frode is a very - he gesticulates quite a bit so we're missing that. We love Richard, but we're missing the gesticulation..

Got it. So I thought you've provided some great color regarding the service fees, et cetera. I'd like to go back to some of the comments that were made in the prepared remarks section. I'm pretty sure that you guys have your own sort of robo-adviser embedded into HealthEquity advisers.

You mentioned the increased costs associated with the DOL fiduciary rule. So I was wondering if you can provide just a little more color about what's going on there.

And then secondly, embedded in that, I'm wondering if the Consumer Financial Protection Bureau also has an oversight role on your business and how that's coming into play as you think about things going forward..

So let me try and take those in turn. On DOL and the fiduciary rule broadly, let me say and this may not be the most popular audience to make this point, but it's nonetheless our view is that the fiduciary rule is a net positive for investors, and we think it's particularly a net positive for HealthEquity members.

Now, there are people who are saying and probably will be reducing the amount of investment advice that they offer to small balance account holders.

We know a thing or two about small balance account holders, and we are absolutely not backing away from offering advice, nor are we backing away from the position we've always taken, which is that when we select funds for our investment lineup that we try to do so with care.

Instead, what we're doing is, from a compliance perspective, in addition to dotting our I's and crossing our T's and all that and reviewing everything we do in this area to make sure that we feel comfortable with it, is we're -- in the end, we will be accelerating the movement that we already had underway towards lower-cost fund lineups and fund lineups where all of the fees that HealthEquity receives are completely transparent.

And the net result for our members is going to be lower investment cost, and that's good.

And you've seen some press from us on this over the course of last, let's say, a year or so, our Index Investor product that we introduced for individuals and now have expanded into small groups, some offering of Vanguard's institutional lineups, some of those kinds of things. And that's going to continue.

And as I said before, we are going to continue to offer our robo-adviser product for those who want.

And so I guess my basic dealing is that while certainly there is some work we are doing on a one-time basis that is specifically related to the fiduciary rule, I think broadly this is a positive for, I think, everyone involved, with the exception of folks who are going to take the view either that this is too complicated for them and/or that they want to deny that this is applicable to them.

And I think there are those folks in the competitive environment who are either going to try and outsource it or somehow talk their way around it or whatever, and that, in our view, is not going to be a good outcome and it's not reflective of market leadership and that's not the way we're handling it.

So if that means we're spending a little more to get it right on day one, then so be it.

But I really do believe at the end of the day, certainly, as it relates to our marketplace that ultimately this is a good protection for investors and we're happy to embrace it and do exactly what we think both the letter and the spirit of the law or of the rule had in mind.

With respect to CFPB, look, we have to operate under the presumption that CFPB, at this point, given the breadth of its mandate, can kind of do whatever it wants. I think anyone who would assume would make the statement, oh, CFPB doesn't apply to me, is probably kidding themselves in any area of financial services.

But at the same time, I'd say, we would -- we sort of welcome the scrutiny to the industry broadly because we feel like, a little bit, at least we try to be [indiscernible] in terms of both transparency and disclosure and so forth. And we may not do it perfectly, and I'm sure there'll come sometime when we find out there's something we've missed.

But without having any insight as to what's on CFPB's agenda beyond what they published, none of which includes HSAs, we have to operate under the presumption that what we do is going to stand the harsh light of scrutiny, and we've tried to do that from day one.

And to find way, Greg, I think it's actually pretty helpful in the sense it’s a little like trying to build the business when interest rates are low. If you assume from the outset that you have to make money and come by it honestly, then you build the business to do that. So that's kind of where we are on it.

And again, I don't mean to be beating my chest about it in any way. I'm sure there will come a day when we will find something we've missed and we'll fix it as quickly as we can when we do. But our attitude is that we're going to embrace a regulatory environment that is aimed at protecting our members because that's what we're trying to do, too..

Perfect. I have two other areas for questions. And your last comment there on interest rates is a good segue. It seems like the interest rates, the revenue that you're collecting, the rate seemed to be ticking up a little bit in the last couple of quarters. And that's in the face of a big deposit growth or AUM growth on your side.

So perhaps you could, and maybe this is where Darcy steps in and provides sort of an outlook of what he sees in terms of bundled assets that are coming off previous deposit arrangements, and then renegotiating on new deals, et cetera, and where the current market appetite is for AUM. And then, I'll ask one final question after that..

Yes. I mean, rates have ticked up very slightly, but sometimes that's just the mix of which depositories they're in. And as you know, we try to just keep this pretty steady and stable and be a fairly steady source.

The biggest change that we ever see is in our fourth quarter that has potentially the impact of when we come in to a new large inflow of cash AUM that will happen every January, that is the time when we have to go out and figure out where to place that money.

And so we're pretty confident in the current year that we have homes for the growth that will occur in the remainder of the fiscal year until January. And then in January, we will enter into some new contracts with either existing depositories or new depositories and it will be very rate sensitive to what the rates are at that time.

And we have some latitude on duration, but we usually don't exercise a lot of -- we keep a pretty tight range on that.

And so we really don't have anything to give on specific guidance at this time, but just knowing that the time when, if there is any dramatic change or even any change, it will generally be coming out when we do our fourth quarter release and we have visibility into that new block of cash and what we were able to place it at..

Okay..

I'd only add one thing to that, Greg, which is it's important to understand, and I think you do, but just to reiterate the point that, when you talk about the rates to which we're pegged, and I think this is particularly important as you're in the neighborhood of the zero boundary here, you're really talking about a market for cash that's somewhat unique.

And so for example, while obviously, broadly speaking, there's a correlation with things like [indiscernible] or whatnot over an extended period of time, that's not necessarily the case and particularly, you do see divergence at the zero bound in part because you see the same thing happening with loan rates, right, that is that banks don't take their loan rates to zero because they can't.

And therefore, there remains a healthy market for particularly mid-term money, which is mostly what we're about on this side of the business. And so I guess I would say, well, obviously, we all recognize that the markets broadly for money are in somewhat uncharted territory.

We feel pretty good about, certainly, as Darcy said, where we are with regard to the deployments we'll have to do in the current fiscal year. And we'll see how things look like next year.

But based on the conversations that the team has with our existing depositories and with the new ones, again, and given the unique nature of what we do, how long we've been doing it, the reputation we've established and the technology that underlies it in terms of being able to be predictable, we feel pretty good about it..

Great. Thank you for that color. And then, I just noticed the final one, I think I asked this of you last quarter, but I can't help myself. The cash and marketable security balance on your balance sheet continues to grow. Can you just give us an update on M&A, et cetera? And then I'll turn over the floor to someone else for questions..

Thank you. I think I just lost the bet there. There was a word that we thought you might use. In any event, so gentlemen's bet, though. .

I know the word..

Yeah. So look, I think first of all, as I think Steve Neeleman talked about. Is it Steve or was it you, Brad? One of them talked about it at our Investor Day, Steve Neeleman. We look at our market for competitive M&A and see -- the way we look at it, we presented a little pie chart at the Investor Day.

Roughly half the market, in our view, are not really in it for the long-term. And so there's going to be plenty of opportunity for that kind of M&A. And the reason I start there is because, as we've said before, while these deals are not going to be transformative, they offer IRR to the shareholders. And that's the way we approach them.

So we're not going to price them up to rush them, but when they're there, we're going to look at them in terms of IRR, and if they make sense, we're going to do them. And if they don't, by the way, we won't. We'll happily pass because we know who we're here to serve. And so there's -- I don't think there's any shortage of opportunity there.

There may be timing issues, but there's no shortage of opportunity. When I get beyond that, and it's sort of worth remembering, our field of view isn't limited to competitive M&A.

And sort of as Brad talked about a little bit, one of the things -- the luxuries we have is the ability to listen to people who have already kind of begun to go through this transition from a world where HSAs and high-deductibles are a minority to a place where they become kind of a norm.

And what props do they need and what stuff is important and frankly, what stuff that you maybe thought was important is less important. And so there are capital deployment opportunities there as well. So I'm not remotely feeling like we're in a position where we won't have great places to deploy that money for high IRR for our shareholders.

And if I were, we'd be giving it back to them..

Got it. Thank you..

And our next question comes from the line of Sandy Draper from SunTrust Robinson. Your line is now open..

Thanks and good afternoon. A couple of questions. First, on the technology and development side, it's sort of creeping up modestly but not a lot. And I keep waiting for the mystery investments that were talked about last year that you guys are going to be talking about that, that might start to ramp up. I'm just trying to get a sense.

I know you guys don't like to open up the kimono and say what you're doing, but do you feel are you doing those things now, are those still on the back burner? I’m just trying to think about, longer-term, where technology spend is going to be trending..

Yes. We are continuing to push on that, Sandy, and we continue to try to, where we can, to accelerate the development.

The one thing that happens in that, as you know, is that we capitalize some of that development, and then put it into a new product enhancement, and then we put it on the balance sheet, and then we amortize that over three years generally. So there's a little bit of lag -- even if we start spending it wildly, the impact on the P&L.

Where you see it is in the amortization line within technology and development, and that has been growing. And so it's just a matter of the way it gets modeled out, and you see it coming and we expect that it will continue. We have not backed off on that at all..

Okay, great. That's helpful. And then, the second -- I know, Jon, it's too early to make the calls on where the year is going to shape up in sales.

But I'm curious, are the discussions you're having, especially from the customers, the questions they're asking or what they're pushing and poking you about, have they substantially changed from last year? Are there new areas of interest, new sort of hot buttons, new things they're focused on? What can you deliver to us as our HSA provider? Has that changed or is it really the same type of questions and discussions that you have last year?.

I'd normally start by offering Steve the opportunity to comment. He's, as I suggested, many of our folks, he's on the road. So I have Brad with me and Brad's in the field as much as anyone. So I'm going to start, Brad, with you, and then maybe I'll offer some commentary..

Sure. Yes, I think by and large, the type of questions and requests that we're getting haven't changed dramatically. We're getting a lot as organizations are looking to promote health savings accounts more and more, getting requests for a more direct education and more touch points for better engagement.

We're getting requests for things that will further improve the user experience in terms of helping the members really kind of plan for the future as well as the shifts from viewing these as spending accounts to being more savings account.

So what tools are we bringing to bear to help them be able to make that shift from spenders to savers? So those are some of the things that are coming out, I think, in the dialog, but by and large, it's very similar to the things that we've heard last year..

Yes, I was just going to kind of take off on this idea of savings versus spend and label it long-term versus short-term.

What I see in the new sales dialogs this year is an increased level of specification on the part of the employers and the like, that this is not a one-year strategy, but it's a five and 10-year strategy, and that a big part of the challenge is communicating [indiscernible] and the implications of that to team members.

And it really is a stretch because as you know, Sandy, so much of health benefits in particular is judged on the basis of one year, and then conversely, so much of retirement benefits is about what happens in this great beyond where we're all retired and just luxuriating somewhere. And health savings is sort of in between those two.

And so I see a lot of interest in, for example, as Brad said, what level of specification are we bringing to that discussion and some, let's say, dissatisfaction with either the answer that is, well, we don't really do that, we outsource it. Or alternatively, yes, we're all about retirement. Let's talk about what happens at age 65.

Because for most of these people, with regard to health savings, that's not the first issue. So we think we're in the right place in terms of helping to meet that need, and certainly the response from our partners has been very positive on it.

But I think that's probably the thing that I see as a trend that's likely to be out there that, simply, a way to look at it, it's an indicator that the partners are becoming more sophisticated about understanding how this is really going to pan out in a world where most people have these kinds of savings accounts that are being asked to manage their health savings in one form or another..

Okay. That’s really helpful. I appreciate it..

And our next question comes from the line of Mark Marcon from RW Baird. Your line is now open..

All right. Good afternoon. Congratulations on a great quarter..

We’re going to call you Macon from now on..

Thank you. [Technical Difficulty] Hey, with regards to the industry, we've seen a significant amount of consolidation over the last 12 months.

I'm wondering, as we're in the heart of the -- or going into the heart of the selling season, as it relates to acquiring new partners and expanding the relationships, what sort of impact do you think the consolidation that we've seen thus far in the industry is going to have? And to what extent would the 50% that's not going to be part of the industry long-term, to what extent does that help?.

I don't know is the honest answer, Mark. I think the buyers out there are not as attuned to all the tos and fros within the HSA industry as all the buzz are. And so I don't want to overstate any impact.

I mean certainly, it's true that if you look at those relationships that have been directly affected by these transactions, there are opportunities there, as we've talked about before. But I hesitate to say something like, oh, it would be nice for me to say, well, people see all these turmoil and they figure, I'd better go with the leader.

That would be great. I just don't know that. As you well know, our partners in the benefits arena are busy people. I have read something yesterday that said that for the first time, the average number of benefits professionals, the ratio of benefits professionals to employees within the average American corporation has exceeded 1 to 1,000.

I guess I did that, that is less than 1 to 1,000. So these are busy people, and I don't know that they're tracking all of the details of comings and goings within our industry. I think they're looking for leaders, looking for people to meet their concerns, and that's their primary concern..

Do you anticipate any increased aggressiveness from some of the players that have been acquiring greater portfolios within the space or enhancing their offering?.

I don't know. They have earnings calls, too. I really -- I think the short answer, I can only tell you what we see, which is, what we see is much more about folks who don't do this all the time and maybe this isn't their sole priority, struggling sometimes to get the transition right.

And I suspect that, that's more of where the focus likely is at this point versus, okay, that's done with, now what should we do? I don't -- that's not meant to cast aspersion. It's a hard thing to do. And it's something we've been doing for a long time and so we can feel good about it.

And frankly, I think the results last quarter, to some extent, reflect that. Some of the gross margin stuff that Darcy talked about, I mean, part of what's going on there is, that's the tale of a very smooth M&T transition. If the M&T transition weren't smooth, then those costs would have shown up as more calls and more issues in the second quarter.

But I suspect that people are much more focused on making -- as they should be, on their side on making sure that, as best they can, that there are new customers happy with their experience. Certainly, if we were in that position, that's what we'd be focused on..

Great.

And then with regards to just the monthly service fees, do we think the current slope of change on the monthly fees that's probably a good place to be, just assuming that interest rates don't change a lot and that we continue to see the increased tiering, et cetera?.

I would say, for the current year that would certainly be true..

Okay.

And Darcy, what do you use as a benchmark in terms of thinking about the effective yield on the cash, given your current duration profile? What do you look towards in terms of giving us a sense for how that market is going?.

One that we kind of look at is like there's published three-year CD rates, we use to get a little bit of a premium to what those rates are because of the stability of our depository base and the ease-of-use for our depository partners. And then, we just look at kind of three to five-year ranges on rates and we're usually playing in that space..

Great.

And then lastly, just as it relates to the DOL regs and potentially some changes on the CFPB, how should we think about the G&A ramp? Is that -- should we -- have we gone through the majority of that or is there a significant further increase to come?.

Yes. As we said, we have invested more. I mean, we have a pretty large sequential increase in G&A. And we're just saying that we think that that's kind of staying there. We don't think that it's going to keep expanding any significantly. We're just making those incremental investments.

And some of them are we're using outside consultants to help us get this right. And so those kind of recurring. So we don't see that there's going to be some huge expansion of that.

We're just acknowledging the fact that we had a significant increase from Q1 to Q2 and that we think that, that will -- that rate -- I mean, not the growth, but the level will continue..

Great. Super. Thank you..

And our next question comes from the line of Randy Reece from Avondale Partners. Your line is now open..

Good afternoon..

Hi, Randy..

So cash AUM per member increased 7% year-over-year. I’m wondering how much of that came from acquisitions and wondering what the real trend is like. There's an -- optically, there's an uptrend. I'm wondering what would be reasonable expectations for future changes in cash AUM per member..

It really depends on account growth and the source of account growth. So what's going on underneath that is a number of account occurrence. As you say, you've got new accounts that we have acquired from others.

And as we've commented, they generally have slightly higher cash balances than native HealthEquity accounts, simply because on average they are older. And then the second undercurrent you’ve got is the influx of brand new accounts. And as you all know, the new accounts start out with much lower balances.

And then the third is the aging of existing accounts. And I'm sympathetic with the challenge of trying to take all those things and put them into an average. But the real answer to your question is, if -- is that there's a link between what you assume about account growth and what you assume about balance growth.

If account growth, particularly kind of brand new accounts, were too slow, then you would see -- obviously, you would see average account balances continue to rise pretty substantially. Conversely, if account growth remains brisk, that will be less the case.

And so -- and we do, occasionally, we have occasionally reported on and others have reported on kind of what the older accounts start to look like, that the balance is due kind of -- the cash balances definitely creep up well above $2,000. And so I guess I'd say, generally, if you're trying to time it quarter-to-quarter, I don't know how to help.

But if you sort of think about it as a long-term, there's this huge chunk of margin growth to the shareholders and benefit to the members that's locked into that existing account base..

You saw right through my trick. Okay. My second question is [Technical Difficulty] well, any kind of detail would have shed light on what your expectations were for account growth. Employment growth in the U.S. is slower than it was in 2015.

Do you think this has a meaningful effect on your company's growth potential in the near future?.

No. I mean, I don't know and know. I think the relative delta in employment growth -- first of all, I just rather have employment growth. Whether it's good or bad for our company, it's another question. Not running for office or anything, but it will be a good thing.

But the deltas are so modest relative to our aggregate growth rates that they're not going to meaningfully affect our numbers. I do think that in a world where -- maybe a slightly different question that you might have asked is really about earnings growth. And broadly speaking, as we all know, corporate earnings growth has not been fantastic.

And so I think that puts a premium, no pun intended, on every dollar of compensation expense being used efficiently.

And the point that, I think it was at our Investor Day, one of our partners made, it was Eastman who was pointing out that this is just a more efficient form of compensation than the alternatives if you look at it over the long term, is to shift some of the costs to the margin but then provide a contribution for the account and get folks educated up on how to use it.

And so I think there's a real opportunity for folks who are looking to squeeze win-wins out of every dollar of compensation expense, which, on average for companies, your comp is 40% of G&A.

To look at the stuff and I think that's kind of what's happening, and that's just the longer way to say, as we said before, the math on HSAs and HSA products works. It may take people time to figure that out, but it works, and that's why the underlying market has grown..

You asked my other question for me, which was, if there's pressure on corporate margins, does that actually help the demand for the shift, not only to HSAs, but to full conversion?.

I think so. I do think, though, at the same time, and to those with perhaps not quite as the long of a telephoto lens, it also speaks to the benefits of having the flexibility on the pricing side on fees. I mean, while as we said before, we're not going to use that flexibility where there's no value to our shareholders.

The ability to go in, in a case where the client sees the long term and they say, oh by the way, I also see -- I'm ready to commit to that and I see -- so I'm asking you to commit with me. And for us to give them everything we can on the fee side, I mean, it really becomes a win-win.

And all that is enabled by the fact that we try very, very hard to get our members doing the right thing. Doing the right thing means growing balances, and if they're going to spend money on health care, spending it through the platform. That's good for them. It's good for us, and we can transfer some of that benefit to our partners.

And so that's kind of a nice virtuous cycle..

Thank you very much..

I hope that sounded very good, I don’t know..

And our next question comes from the line of Alex Paris from Barrington Research. Your line is now open..

Hi. Good afternoon or good evening. This is Chris Howe sitting in for Alex Paris..

Hi, Chris..

Hey, I just had a few questions for you here.

Would you be able to describe any trends you're seeing among new adopters or perhaps, asked a different way, would you be able to provide color on certain demographics, industries, locations, kind of a segment analysis of things that may be showing better acceleration than other parts of the market?.

We don't typically provide too much breakdown in that regard, in part because we don't see what we're doing as an industry-specific phenomenon. But let me say this.

I think what you're starting to see -- what you are seeing is, as this industry continues to grow and we were sort of trumpeting our growth relative to Devenir and the market, but the market is still growing 20% plus. And so by definition, you are moving into, let's say, more mainstream pragmatic customers.

And what do pragmatic customers want? Pragmatic customers want to know that you're going to take care of their team members. They want to know about your service record. They want to know how long you've been in the business. They want to know the things along those lines.

They want to know what the investment lineup looks like and if they're going to be treated fairly and all that kind of stuff. They want to know that you're thinking about security.

And I think those are the questions that work really to our benefit as a specialist within -- not only within the benefits arena, not only within the tax advantaged account whatever arena, but really focused on the HSA.

And there are other things we do, of course, but that kind of focus of the buyer on the nuts and bolts of delivery really is something that we relish. And so I guess that's probably the biggest thing that I could say in answer to that.

And where you see that is a lot more pre-buy security audits that are really in depth as opposed to just the usual we'll send our consultants out for three hours kind of stuff.

That kind of thing, more valuation of people actually asking questions about the investment lineups, which they really should and we wish more did, because we have great answers, people asking the difference between someone like us who's a custodian that's taking future responsibility and someone who says, well, I'm just the administrator.

If you actually have a problem, you may have to go somewhere else. Those kinds of things. So I think that's the biggest -- if you want to call that a demographic change, demographic that we see. But broadly speaking, of course, there are always going to be leading and laggard sectors.

We've talked before about the fact that surprisingly, the health care sector, meaning hospital systems, physicians, et cetera, have been a great market for us and continue to be a great market for us.

We offer some pretty unique and interesting solutions in that market and you might not think of that as being the kind of market where this stuff would really take off. But -- and then, there are always going to be some laggards, too. But broadly, we see what's going on as more broad than [indiscernible]..

Okay. Thank you for the color. That's helpful.

I think you touched on it briefly on the last quarter call in regard to max savers, whether it be pertaining to the absolute number, was there any, I guess, positivity or anything measurable in the quarter that showed some growth among the space?.

Well, Brad, why don't you talk a little bit about what we're doing to try and encourage our folks along the savings line? I may have liked, but not expect to answer this one..

It's all right. So it's important to remember that to truly build health savings, you need to educate and engage the member. And at the heart of that engagement, it needs to be very personalized.

And so we're really focused on data analytics to understand this journey that our members, and when I say members, that each individual member is going on, right, because every individual member has a different journey. Some are very similar, but we're focused on using data, and then using our platform to flex to meet their needs.

And in looking at the data, there's lots of opportunity for us to continue to our mission of building health savings. There's lots of members that really probably should be contributing more than they are, and our vision and mission is to engage them in a way that is personalized and meaningful to them, to move them along that continuum of savings.

And we're really focused on doing that through data analytics, leveraging our open platform to be able to flex to meet their needs and create that personalized experience..

Thank you. And one last one for me. Perhaps this is not the time, but I just wanted to get some overall view on when it would be appropriate to provide longer-term financial targets? I think in the past, you had mentioned some things about margin potential.

Just kind of want to see where your stance is on that moving forward?.

Yes. Today, we have -- we give fiscal year guidance from year to year. At the time of the IPO, we did give some kind of broader growth targets for both the revenue and for adjusted EBITDA. And we have -- so we've been public just over two years now. And we've exceeded both of those targets.

The revenue target was to grow from 25% to 35% and the adjusted EBITDA was to grow from 35% to 45%. And on both counts, we've exceeded those ranges. And so we're not really reiterating new longer-term guidance ranges, but that's the only that we've ever given in the past.

We'll revisit that to see if we can give anything in the future, but that's where we're at today..

We'll put some thought to it..

All right. Thank you for taking my questions. I appreciate it..

Thank you..

And I'm not showing any further questions at this time. I would now like to turn the call back to Mr. Kessler for any further remarks..

Well, thanks, everyone. I hope everyone had a great Labor Day and ready to get back to work as we are. So see you in a few months. Thank you..

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a wonderful day..