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Operator: Good afternoon and welcome to the HealthEquity Fourth Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Richard Putnam. Please go ahead.

Richard Putnam: Thank you, Gary, and happy first day — first full day of spring to everyone and welcome to HealthEquity’s fourth quarter and fiscal yearend 2023 earnings conference call. My name is Richard Putnam. I do Investor Relations for HealthEquity and joining me today I have Jon Kessler, who is our President and CEO, Dr. Steve Neeleman, our Vice Chair and Founder of the company, and Tyson Murdock, the company’s Executive Vice President and Chief Financial Officer. Before I turn the call over to Jon, I have two important reminders. First, a press release announcing our financial results for the fourth quarter and fiscal 2023 yearend was issued after the market close this afternoon. The financial results and the press release include the contributions from our wholly owned subsidiaries and accounts that they administer.

The press release also includes definitions of certain non-GAAP financial measures that we will reference today. A copy of today’s press release, including reconciliations of these non-GAAP measures with comparable GAAP measures and a recording of the webcast can be found on our Investor Relations website, which is ir.healthequity.com. Second, our comments and responses to your question today reflect management’s view as of today, March 21, 2023, and will contain forward-looking statements as defined by the SEC, and that includes predictions, expectations, estimates or other information that might be considered forward-looking. There are many important factors relating to our business, which could affect the forward-looking statements made here today.

These forward-looking statements are subject to risk and uncertainties that may cause the actual results to differ materially from statements made here today. We caution against placing undue reliance on these forward-looking statements, and we also encourage you to review the discussion of these factors and other risks that may affect our future results or the market price of our stock and they are found in our latest annual report on Form 10-K and subsequent periodic reports filed with the SEC. We assume no obligation to revise or update these forward-looking statements in light of new information or future events. At the conclusion of our prepared remarks, as Gary just mentioned, we’ll open up the call for Q&A and we’ll turn the time over to him to instruct us on how we do that.

And then I have one final announcement before we hear from Jon; we plan to hold our next Investor Day on July 11, later this year. We hope that you’ll be able to make plans to join us and please stay tuned for more details as they come available. Jon, over to you.

Jon Kessler: That was fun. That last part. Good afternoon, everyone, and thank you for joining us. I am going to report on key metrics as always, and then discuss management’s view of fiscal ’24 in light of current conditions. Tyson similarly will touch on Q4 and fiscal ’23 before detailing our revised guidance for fiscal ’24 and of course, Steve is here for Q&A. For fiscal 2023, we are pleased to report double-digit year-over-year growth across revenue, which is plus 14% adjusted EBITDA, which is plus 15%, HSA members plus 11%, and HSA assets plus 13%. Total accounts grew 4% and muted by CDB underperformance and a change in methodology with no revenue impact. HealthEquity ended fiscal ’23 with nearly 15 million total accounts including eight million HSAs, more than $22 billion in HSA assets, nearly a million new HSA opened in the year, record numbers of clients and network partners, strong yearend service, thank you team and number one, market position and so as a result of all that, we are able today to raise our outlook for fiscal ’24, which Tyson will detail.

We expect revenue to again grow double digits, EBITDA growth to accelerate to around 20%, even faster growth in non-GAAP net income and a return to positive GAAP net income, which is good. Our outlook factors in health equities inherently strong visibility to future performance as well as our belief that the current crisis underscores the valuable stability of HSA balances combining as they do the stickiness of individual small balance accounts and individual tax advantaged accounts. While US commercial bank deposits fell 0.9% in the first two months of calendar ’23, for example, HealthEquity’s, HSA cash grew by 6% in that same period and that growth has continued through the banking crisis that began on March 08. Meanwhile, overall job creation continues its strong rebound from pandemic lows, which contributes to new HSA openings.

As Tyson will detail, our outlook does reflect current interest rate expectations and a more neutral rate of job creation going forward and of course, we’re closely monitoring the condition of bank and credit union participants in our basic rates program, insurers in our enhanced rates program, bank holders of client held CDV funds and of and holders of health equities operating cash to assure that all continue to meet our strength thresholds. With that, I will turn it over to Tyson to detail the results and guidance Mr. Murdock.

Tyson Murdock: Thank you, Jon. I will highlight our fourth quarter and fiscal year end GAAP and non-GAAP financial results, and there’s a reconciliation of GAAP measures to non-GAAP measures to be found in today’s press release. Fourth quarter revenue increased 15% year-over-year. Service revenue was $114.2 million, up 2% year-over-year. Custodial revenue grew 44% to $83.5 million in the fourth quarter. The annualized interest rate yield on HSA cash was 211 basis points during the fourth quarter of this year, which brought our full year average to 190 basis points. Interchange revenue grew 10% to $36.1 million. Gross margin was 57% in the fourth quarter this year versus 52% in the year ago period. Net loss for the fourth quarter was $0.2 million, which rounds to $0.00 per share on a GAAP EPS basis.

Our non-GAAP net income was $31.3 million for the fourth quarter this year and non-GAAP net income per share was $0.37 per share compared to $0.20 per share last year. While higher interest rates increased revenue, they also increased the rate of interest we pay on the remaining $341 million term loan A to a stated rate of 6.3%. Adjusted EBITDA for the quarter was $73.6 million and adjusted EBITDA margin was 31%. For the full year of fiscal ’23 revenue was $861.7 million, up 14%; GAAP net loss was $26.1 million or $0.31 per diluted share. Non-GAAP net income was $114.5 million or $1.36 per diluted share. And adjusted EBITDA was $272.3 million up 15% from the prior year, resulting in 32% adjusted EBITDA margin for the fiscal year. Turning to the balance sheet, as of January 31, 2023, we had $254 million of cash and cash equivalent with $925 million of debt outstanding net of issuance costs.

This includes the $341 million of variable rate debt I mentioned earlier. We have an undrawn $1 billion line of credit. So we have a strong balance sheet with reoccurring revenue model, and now we expect the following for fiscal ’24. We expect to generate revenue in a range between $960 and $975 million, and we expect GAAP net income to be in a range of $0 to $11 million. We expect non-GAAP net income to be between $152 million and $163 million, resulting in non-GAAP diluted net income between $1.74 and a $1.87 per share based upon an estimated 87 million shares outstanding for the year. We expect adjusted EBITDA to be between $320 million and 335 million. As a reminder, beginning in fiscal ’24, we are basing future interest rate assumptions embedded in guidance on forward-looking market indicators such as the secured overnight financing rate and mid-duration treasury forward curves and fed funds futures.

We now expect an average yield on HSA cash of approximately 230 basis points in fiscal ’24 up about 40 basis points from last year. We continue to assume that the average crediting rates our HSA members receive on HSA cash will increase by five basis points per quarter in fiscal ’24. And finally, our guidance reflects the expectation of higher average interest rates on HealthEquity and billable rate debt versus last year, consistent with the current forward-looking market indicators. We assume our projected statutory income tax rate of approximately 25% and a diluted share count of 87 million shares, which now includes common share equivalence as we anticipate positive GAAP net income this year. As we have — as we have done in recent reporting periods, our full fiscal 2024 guidance includes a reconciliation of GAAP to the non-GAAP metrics provided in the earnings release, and a definition of all such items is included at the end of the earnings release.

In addition, while the amortization of acquired intangible assets is being excluded from non-GAAP net income, the revenue generated from those acquired intangible assets is not excluded. With that, we now know you have a number of questions. So let’s go right to the operator for Q&A.

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Operator: We will now begin the question-and-answer session. Our first question is from Anne Samuel with JPMorgan. Please go ahead. Q – Anne Samuel Hey guys. Congrats on that terrific quarter and thanks for taking the question. My first one was, I was just hoping you could speak a little bit to the enhanced rates product. I don’t think I heard you say, what proportion of deposits are in it now. And just maybe, where is that expected to go over time? How are you thinking about that as maybe a potential tailwind for yields or maybe just a stabilizer? Thanks.

Jon Kessler: Yeah. Thank you for asking the question Anne, and it’s good to hear your voice. So we ended the year north of our goal of 20% of our HSA cash and enhanced rates. And I think just as importantly we ended the year with a growing set of partners in this space amongst large and highly rated insurers. And so we think that both the demand is there for this and then the supply, if you will, from our members is there for it. And so our expectation continues to be that this product is going to grow that it’s going to grow. I think we’ve said elsewhere something on the order of about 10% of our HSA cash a year, and that’ll depend a little bit on, factors like the underlying speed of the HSA cash growth and whatnot. But, I think that’s a good conservative estimate.

So, maybe, we’ll certainly be north of 30% by the end of this year. And further our expectation, based on what we’ve seen here is, as you said, that this is both a really nice — there is a net growth opportunity because the yields on enhanced rates as the name suggests are sort of always or almost always a little bit higher than they are on our basic rates product. But so that’s good for us and good for our members, but it’s also stabilizing and we’ve kind of seen that during this period where when there was a — when rates on the bank side were falling, the premium to this product was very high when rates were rising very rapidly, the premium was somewhat lower. But, all of that produces net stability in that underlying custodial yield, which is what we’re going for.

So, it’s kind of full steam ahead with this product. Q – Anne Samuel That’s really helpful, caller, thanks. And then I was just maybe hoping you could touch on how some of the recent banking volatility might impact your business. Realize you don’t have any de depositories that are impacted, but you often speak about the primary driver of yield being competition for deposits. So just wondering how this might impact that.

Jon Kessler: It’s interesting. You’ve got it exactly right. And what we saw during this period is the value, what we’ve seen during this period is the value of stable deposits and that value of being a good, in our case, a good customer of these depository institutions, right? Whereas, well reported you saw these banks and other institutions that were heavily dependent on corporate deposits, see big flows. That’s not what we saw. Our members were extremely steady for all the right reasons. These are long-term tax advantaged accounts. They’re small balance, they’re FDIC insured at the member level, etcetera, etcetera and there are real penalties and so forth to moving your money. And so people, what I think this crisis on the banking side has kind of showed is that all deposits aren’t equal and we offer a great source of funds for institutions that have real loan demand, not sort of created in money markets or the like.

And that’s who we do business with and we feel really good about how we’ve responded in terms of both how our members have responded. Of course, as a team, we went into the same with all the unknowns of two weeks ago. We went into the same kind of crisis management mode as everyone else did to make sure that things were okay. But, I can’t tell you how much this demonstrates to us, and I think ultimately to our partners across the banks and the insurance companies that this is why this is a very stable source of liquidity when they need it.

Operator: The next question is from Greg Peters with Raymond James. Please go ahead.

Greg Peters: Well, good afternoon everyone. I guess I’d just like to build on your answer from the last question about, the chaos that’s unfolded in the bank channel. And then, not only have bank prices gotten killed, and there’s been some companies that have been called in question, we’ve seen pressure in the life insurance industry. So I know you were talking about the value of your de deposits from the perspective of how your depository partners might look at it. But can you talk to us for a moment about the credit risk that you’re considering as you established these partnerships, not only with the depositories, but also with the life insurance companies, and maybe how that might have changed in the last couple weeks?

Jon Kessler: Yeah, I think fundamentally, Greg the things that you would be concerned about, let me — the first thing that we are concerned about, it’s not — I don’t even get into issues of asset quality. I want to start with issues of whether for the insurer, whether the liability side of the balance fee is strong, meaning whether these are truly illiquid and so forth. And so there’s real good coordination and that’s had an impact on the kinds of insurers that we want to do business with as we start this program. As you well know we have largely steered away from the folks that are relatively newer into the space that have gotten in on the back of private equity, money accumulating that kind of thing, and have tended to focus perhaps at the expense of some premium on return.

Have tended to focus on winning partners who have been in the insurance business across multiple lines for not just tens of years, but as in some cases hundreds and that’s served us well here. So, we obviously do monitor. The nice thing about the insurance side is we get a ton of data and we get it in rough real time. And so we have been able to monitor very closely things, the kinds of issues that people have talked about in the bank space with regard to both the liability and asset side of those institutions. And they have performed extremely well, exactly as we would’ve expected. I think where you’re seeing more stress is I think in institutions where the growth of the balance sheet is a relatively new phenomenon. And so, not dissimilar, I think you’ve heard me say before on the bank side where we get very cautious when someone is looking to us as a means to sort of launch a business plan on the bank side or and the regulators don’t want us to be necessarily the source of rapid balance sheet growth.

They want us to be the source of stability, and I think we’ve sort of taken the same approach with the insurers. And again, I think that’s serving well from the perspective of our goal, which is ultimately, getting the most for our members and for us, but in the context of stability. So it’s a great question and it does seem like it’s playing out in the way that we would want thus far.

Greg Peters: Well okay. That’s helpful. I guess the other question that comes to mind, there’s the credit side, but then there’s also the business side of what’s going on. So, can you, as we think about the selling season for HSAs and the other accounts, can you talk to us for a minute about how you might have exposure to different industries, say the banking industry versus start-up tech companies versus, you have almost eight million HSAs. Can you give us a sense of how that is spread across different sub-sectors of the economy and when we think about the selling season, if there’s layoffs in the tech space, is that going to affect your outlook more disproportionately than if there are layoffs in the banking space, etcetera?

Jon Kessler: Sure. maybe, I’ll make that a two-parter, Steve. I appreciate if you would chime in here Steve’s in Washington today, and I assume you can nonetheless, yet. We’re not on TikTok here. So I assume you can nonetheless get reception and is on this call. Maybe you can talk a little bit about how our prospects and our health plans and the like, have reacted to what’s going on in the last few weeks. And then I’ll sort of address the broader client concentration question.

Stephen Neeleman: Sure. Thanks Jon. Hey, Greg. Good to hear your voice. I think that anytime there’s instability, people always pause a little bit, but, I think the good news for us is that we’ve seen this movie before, right? We’ve been through the GFC, we went through COVID, and the one thing that just keeps coming back around is that when employers are worried about their bottom lines, when they’re worried about, what the future beholds, they really do look for ways to save some money for not just their own premiums, but I think more importantly for the people that work for them. And they know that HSAs can do that. It can help them get a lower cost premium, it can help them save money on taxes, and it can really help prepare their folks.

And so Greg, and then, with our 130 health plan partners and another 40 different types of partners, we have such a wide variety that we’re not really that concentrated in any specific industry. It’s pretty amazing, honestly. There’s been, I think if you just look across the sectors of types of businesses, we have everything from hospital systems. We do have some tech, but not thankfully, the tech companies we’ve been working with have not been heavily adversely affected. And so, we can never say never that it’s going to impact us, but, we have seen this and I think we’re pretty well diversified and hedge from that perspective, and we just keep hearing the same thing come back that keeps coming back around, which is, yeah, recession could be in front of us, but this is the best time to help employees understand that when dollars are tight, let’s get you into a lower cost premium plan.

Let’s get your tax rate lower and let’s help you start saving. And, so we’ve seen Greg a strong an RFP season as we’re starting to gear up as we ever had. I think that’s consistent with what we were able to do last year, having a record sell year. Almost a million health savings accounts and so look, we’re always, I think, productively paranoid around HealthEquity. We’ve known us for a long time. That’s the way we roll. But on the other hand, we’re, I think we’re pretty enthusiastic that we’re going to keep the momentum going. Jon, do you have other stuff you wanted to add that sounded like,

Jon Kessler: Yeah, look, as I sometimes do now I know how it feels, you took my half of the answer too. I’ll only add that, our guidance Greg does as both Tyson and I said in one form or another, our guidance reflects the view of a more neutral view of job creation. And I think that’s a fair way to look at the full year, notwithstanding the fact that the jobs numbers we’ve seen thus far in the first few months of the calendar and fiscal year have been pretty heady. It’s a reasonable view to say that whether or not we go into economic recession, that that job creation will likely slow down. And that’s the way we’ve constructed guidance. So, it’s just another factor to kind of keep in mind.

Greg Peters: Great. I, I appreciate the answers. Yeah,

Stephen Neeleman: See, I haven’t said one thing to in any way tease you. I’m playing it well, a 100% right down the middle.

Jon Kessler: I was just going to add for the clothing requirement for your Investor Day, and maybe we can include some Bermuda shorts. That seems to be pretty popular.

Stephen Neeleman: Funny you should mention that. It’s funny, that will be in the invite. Suffice it to say, it will be in a warm location, right? A warm-sum location; it’s Salt Lake City, but nonetheless, I’m letting that cat out of the bag. We’re doing — we’re doing Salt Lake, we’re getting the Utah people out to, it’s going to happen. It’s going to be fun. It is going to be fun, by the way. It is going to be fun. So we hope that folks can’t join us.

Operator: The next question is from Sean Dodge with RBC Capital. Please go ahead.

Sean Dodge: Yep. Thanks. Good afternoon. Jon, just going back to your comments about the benefits or the stability of your HSA deposits and those becoming increasingly attractive, given all that’s transpired, just maybe to put a finer point on that, is that something, is this increasing attractiveness, something you can monetize going forward in the form of generating higher yields on those types of placements, kind of all else equal? Can you get a little bit more of a premium because of that?

Jon Kessler: I think the answer to your question is — the answer to your question is yes, that the key point being all else being equal. I look at it like or I guess I’m maybe stealing the words out of the mouth of our newly appointed treasurer and saying, this is making my introductions to institutions that the company has dealt with over many, many years, a lot more friendly. And presumably that good feeling will last. I also think it’s true that the fact that we were not in in the mode of moving this money around willy-nilly over the course of Thursday and Friday, of the week of March 08, it’s not that we couldn’t have, and it’s not that we didn’t pay very, very close attention on what’s going on. But, ultimately the fact that we were able to do that, I think, breeds confidence and breeds is the kind of thing we want to be as a partner.

So when those renewals come up, those are likely to be more effective renewals. So, I do think you make friends and or lose friends very quickly in these moments, and you shouldn’t be making, and we’re not making decisions on the basis of friendship, but when something works, from the perspective of safety, when safety is needed, people don’t forget that. And so, I do think ultimately, when you think about the long-term durability of the premiums that we’ve generally been able to earn on relative to what banks have been willing to pay elsewhere this is a really nice event from that perspective.

Sean Dodge: Okay, great. And then on the enhanced product, you said looking ahead, the, the goal is to shift, give or take 10% of your portfolio over there per year. You also said both demand and supply are there and so what’s keeping you from shifting more of it in any given year? Is it just because there’s a limited number of partners still and so only so much demand for those types of deposit, or is it more on the individual account holder side and just getting them on board and kind of the mechanicals of what you need from the account holder to ship?

Jon Kessler: No, I think there are two factors, Sean. One is that we don’t want to create a uneven ladder, if that makes any sense where we too, let’s say have, well, three factors. One is we don’t want to create uneven ladder. That is to say, were we to let’s say, have a movement of 30% or 40% of our deposits in one year, you would then be asking us, X years from there, well wait, have we created uncertainty about the redeployment of those assets? And we don’t want to do that. That’s not good for how we manage the business and it’s not good for our shareholders. So that’s kind of issue one. Issue two is that we are learning as we go and learning is, I think as are our partners and so that is, it’s probably fair to say that the demand for this program today among would be partners is higher than it was a year ago.

Well, part of the reason is because it’s existed for this long and people have watched the results, and there’s a level of confidence in those results. The last factor, which is of course relevant is that the source of these assets, in addition to new members contributions to HSA, is existing members. And so we also have to manage our FDIC commitments, meaning our bank deposit commitments. And so, we were able to in this cycle, we were able to deploy less into banks than we would have without the existence of enhanced rates and again, that allowed us to be, I think, appropriately choosy, both in terms of economic return and other factors. And so that — but that’s also a bit of a breaking factor too. That is to say we want to make sure that we still have plenty of liquidity to meet all of our minimum commitments there.

So within those three parameters, which are really in my view, the key to this, ultimately we feel like we’re moving a pace. Member interest has been there, no pun intended, has been there the whole time and I think if we were devoting, if our sole objective was to move as fast as we could, we would be doing so with — we’d be moving faster with a heavy marketing emphasis. But I don’t think that’s what we need to do right now. We’re happy to have — with this element, a multi-year tailwind that will contribute to even longer term stability.

Operator: The next question is from David Larsen with BTIG. Please go ahead.

David Larsen: Hi, congrats on a good quarter. Can you talk about the increase in the revenue and EBITDA guidance? What are the main drivers of that? And then also it looks like the interchange revenue increased sequentially from about $33 million up to $36 million what was the main driver of that, and was that ahead of or in line with your expectations? Thank you,

Jon Kessler: Tyson, you want to take those?

Tyson Murdock: Yes. So from a revenue perspective, when we gave guidance back on December 06, and you look at for example, the average CD rates jumbo CD rates, and you look at things like LIBOR, SOFR rates, they were actually lower then. So we got a tailwind from those that we would be putting into the yield rate as well as to the revenue top line. And then, just going back down to the plan from a perspective of profitability and the flow down of those custodial revenues, that’s why you see the bottom line lift up as well and so you have essentially that running down through the plan and we knew that would be the case and believe we’ve called it out at that time as well. And then the second question was the interchange, yes. So

Jon Kessler: That’s quarter-over-quarter sequential interchange.

Tyson Murdock: Yes, quarter-over-quarter sequential. You have more accounts and you have the seasonality that typically happens in Q4. And, we sold a lot of accounts, we brought those online. We have the seasonality. It was much more normal this time around than it has been over the last couple of years. And so that was probably to be expected. And we feel like that’s sort of stabilized itself.

David Larsen: So when you say seasonality, do you mean more people are going to the hospital using their health card? So utilization has increased, so that’s where that increase came from?

Jon Kessler: No. It’s more — it’s more about the normal seasonality of those card usages. So when you think about, for example, they’ll use it or lose it, nature of an FSA, towards the end of the year, people are going to use up those funds. You think about when a HSA is funded from an employer standpoint in January, sometimes people typically utilize those funds at that time. And so you have a normal seasonality in Q4 that occurs there, and you sort of have that flow into Q1, and then you get a much softer Q2, Q3 and that would be the more normal reps of the business that we haven’t necessarily seen over the pandemic era.

Tyson Murdock: I think David, one of the things about the nature of our fiscal year being January 31, is you got that January month where people begin a new plan year and haven’t met their deductible until pretty much everything’s out of pocket.

David Larsen: Okay, great. And then for the $22 billion of managed assets, is all of that FDIC insured every single one of those accounts?

Jon Kessler: No. So if I look at — I’ll take this one now. If I look at our overall custodial assets you can divide that first into two pies about $14 billion of it is what we call extra cash and the remainder is invested. The invested assets are obviously not FDIC insured. They’re in mutual funds and the like at the member’s discretion. So I think you understand that. If I look at the cash component it has two elements. The bulk of it is in our basic rates product, and all of those funds are in FDIC member institutions or NCUA, I guess, member institutions that offer pass through insurance to our members, subject to the usual $200,000 limit, which generally an HSA is not going to reach almost exclusively. And then with the enhanced rates product these are not FDIC insured.

They’re not deposits. These are as we’ve talked about before, these are group annuities that are insured by highly rated insurers that are again, entered into at the direction of the members. So that’s sort of the breakdown there. I guess I would add to all of that, what all of those have in common is, we do not bring — our members aren’t paying us to be a principal risk taker. We are not a principal risk taker. We don’t bring principal risk onto the HealthEquity balance sheet.

Operator: The next question is from Stan Berenshteyn with Wells Fargo Securities. Please go ahead.

Stanislav Berenshteyn: Hi thanks for taking my questions. I’d love to get an update — I’d love to get an update on your MaxEnroll product. I think it’s probably been out for a year or so, if I recall correctly. I’m just wondering how widely has it been adopted by your clients, and do you have any sense how much of your member growth this past year could be attributed to MaxEnroll? Thanks.

Jon Kessler: Yeah. We began to address this, I believe in the well, we talked about this somewhere now, I don’t know where, so I guess I probably should hear. So sorry, I got the — I heard beats there for a second. So Stan, the way we’ve approached this, first of all, for as a reminder for everybody MaxEnroll is a product that is really about addressing not just our existing HSA members, but would be members in HSAs. And in addition this year we also applied it to a portion of our — or applied this technology portion for our FSA population. And we’ve had the greatest penetration of this product within what we call our managed client base. So this is our groups roughly 500 of them that have a name to account executives and the like, and I think that’s appropriate and then we have a more, I’m going to call it generic version of the product that is available for download and so forth that our smaller groups can use and, I think we did well this year.

We’re still, I would say in the — we may be beyond the nail it and now in the scale at stage, but we’re still in the early part of the scale at stage of this thing and there are good reasons for that. We still have, I think, work to do to make the product truly effortless for our clients to have it more deeply integrated. What we found this year was where we did the best was where we were more deeply integrated in terms of data with other things that our clients were doing within open enrolment. So, where we understood precisely, where from a data perspective we could understand precisely what their open enrolment dates were, when things would begin and end. And so we could show people timers and those kinds of things, which seemed trivial, but they created more immediacy about action, and that was extremely helpful where we understood what our clients were trying to do in terms of the pricing of their various health plans.

And so we could speak that language within this stuff or give them the tools to do so. That was extremely helpful. So, I think we did reasonable well — so we did well this year. There’s more gain to be had. And from the second part of your question, which was how much of this thing contribute? I think I’ve estimated elsewhere that if you look at the gains that we got from existing clients that were over and above what we might have expected without this product it probably gave us, somewhere between 50,000 and 100,000 new HSA openings over the course of this cycle. And that’s probably maybe a little bit of an exaggeration because, obviously there’s some favourable selection with these clients where people who are really interested in, in growing the HSA base are more likely to really get aggressive with this and use it to its fullest extent, but you kind of get the idea.

So it was an absolutely a material contributor to the over performance that we saw this year on a year-over-year basis.

Operator: The next question is from Sandy Draper with Guggenheim. Please go ahead.

Alexander Draper: So I guess it’s going to try to be one question, but it’ll sort of wrap a couple of things together. When I just, when I look at the cash flow, you’re starting to see an improvement in your cash from operations. The capitalized software is moderating. You did step up a little bit on M&A, but if I think about your guidance, your net income and your EBITDA is up. If I look at the add back, some of the cash add backs, integration costs are going down. So it looks like net-net of all that is free cash flow and cash you have is, looks like it’s going to be pretty good and hopefully sustainable. So when I think about the M&A environment, what’s that like? But then also, I know Tyson indicated you’re at, I think he said 6.3 is the stated rate, maybe on the floating rate debt. How are you thinking about debt pay down versus M&A or any other internal investments and balancing those three things out. Thanks.

Jon Kessler: Awesome question? Thank you. Real, it really is. We were — this is actually — we probably spent a half hour in our prep just kind of thinking about how to answer this in such a way that like, it’s like sometimes you have things where you want to answer and you like, but you don’t want to like give them everything. This is one we’re like, I want give you everything because, it’s so, it’s such a fun, interesting and important capital allocation problem. But, and I’m going to resist doing that, because that’s what the team told me to do, but a couple thoughts. First of all the premise is right, that is to say that, if you look at fiscal ’23 we converted, EBITDA free cash flow at a rate pushing 60%, that rate’s coming up.

Well, why, because integration expenses are coming down, and that was a big add back, etcetera, etcetera. But as you say, one break on all of that is the interest on the relatively small, but nonetheless they’re variable portion of debt. So, you’ve got all of the right factors that we’re looking at in terms of where to deploy capital here. I think if I look at the M&A environment a couple of things really strike me. The first comment I’ve made elsewhere, which was, we are absolutely not in a rush to do anything from an M&A perspective material that is in the nature of let’s go horizontally expand to this, that, or whatever in the way of existing established markets. We’re not in a rush to do that, both because we think that our clients aren’t demanding that we do it, that valuations are plenty fulsome out there and that we can deliver more shareholder value at this point in time through the work that we’re doing on the organic side and with partners to kind of develop product that isn’t established out in the marketplace and, so our inclination is not to go out on the sort of horizontal side and deploy capital there.

If I look at competitive consolidation, you part of my answer, which is we’re always interested in attractive transactions that have high IRR for our shareholders. I think for all of the reasons we talked about, both at the beginning of the call and in the first answer about these deposits being very steady for the banks at the moment, I’m less sanguine even than I was a few months ago, that like, there’s going to be a material transaction that’s going to develop in that area. I just that is how it is and I think that’s totally fine. There’s no reason for us to run around pricing those transactions into the market or the like, and it’s a reflection of the quality and steadiness of the underlying business. So, that being said, we do have to — we then are looking at and should be looking at like what’s the purpose of maintaining that the outstanding TLA and its current size when we obviously have the capacity should we need it for pretty much anything that we would contemplate and we are looking at that.

So I probably did just give you more than they told me to give you, but that’s the full answer.

Operator: The next question is from George Hill with Deutsche Bank. Please go ahead.

George Hill: Good afternoon guys, and I’ll say, now I’m bummed out because Sandy took my cash flow question. So I guess what I’ll roll into is maybe talk a little bit about expectations for the CDB business in ’24. Is that something that we think shrinks again next year? Or is it poised for stability in a rebound and I’ll have a quick follow up.

Jon Kessler: Yeah. You can’t just claim credit for Sandy’s question that doesn’t, that doesn’t fly with us.

George Hill: But Jon, I had a four part cash flow question here written out in my notes, and he basically asked for the part of it,

Jon Kessler: So, look on CDB, as you as folks will recall, I was hopeful that we could put, a black single digit on the boards coming into ’24. We didn’t quite get there because Cobra remains weak. And that’s probably the biggest problem. And we are going to have to really look at it and understand a little better or understand as well as we can what our levers are. I think, what is fair to say is that our guidance with regard to revenue generation in the current year reflects a level of conservatism on this topic. But that it is pretty clear that we know what to — but that having been said, that sales are, have actually been pretty good. Our challenge, George has been the platform movement and all of that. And if I could be convinced as well as the regulatory issues that kind of brought us up and then brought us down around the national emergency, and if I could be, if I weren’t convinced that all that were behind us and that we that’s not just we, but employers had fully digested the implications of all of that, I’d probably feel more confident in giving you a view that I’m not just hopeful, but comfortable that from a sales perspective, we will be able to put up a black zero, a black number here.

It’ll still be a single digit number, but a black number. I’m just not as convinced of that. Do we know, obviously if employment slots off, will that be somewhat good for Cobra? Yes. Right. Has anyone figured out what Congress is going to do with the existing effectively competing subsidies in the ACA marketplace? No. Right. Does, does everyone fully figured out the national emergency end, that’s going to happen in a few months? I think we know what the implication is for our business immediately and we forecasted it, but I, I’m not sure everyone’s fully digested it. So, I guess my answer is it unfortunately, I feel like we’re still in a mode where I can’t beat my chest about this thing yet.

George Hill: No understood. And, and if I can have a real quick follow up, I guess, are you seeing anything in benefit construction and benefit pricing and the things that I’m kind of leaning on right here and thinking about, or like what’s going on in the insulin market where you’re seeing much lower out of pockets for patients on insulin, I guess, are you seeing any of these changes either in benefit pricing or benefit design that has the capability to either, I’m thinking about it could like lower your interchange fees, but it might increase your average balances as people tip into their HSAs less as they’re out of pockets fall. Would you be interested in how you’re thinking about kind of those parts of the market and kind of how those pieces move together?

Jon Kessler: Well, I’ll comment on this and then invite Steve to comment further. I personally think that this stuff that’s going on right now with insulin as an example is, and I’m sure I’m stepping on somebody’s toes here, but I think it is both fantastic and incredibly realistic, right? What it’s doing is it’s giving people certainty and certainty is really important for people. We talk about being in the business of connecting health and wealth. It is hard to talk about that in a world where people think that every healthcare transaction that they have, they’re being cheated by somebody on it. And so my hope is genuinely that from a plan design perspective and frankly from a legislative perspective and we’re and this maybe where Steve will comment a little bit, we’re — these are our issues that we’re starting to weigh in on, that we’re able to bring people greater certainty with regard to the routine kind of medications and the like, that are part of their regular daily lives.

There’s no reason we can’t. These are now incredibly low cost items at this point. And, insulin is an example, but there are many others. They’re actual out of real cost is low. And yet we and it’s low in HSA plans too, right? It’s just that we’ve like scared the heck out of people because of the way we all talk about this and we can create certainty, which creates real value. And so that is something I do see employers looking at as they go to plan design. Steve, you want to comment further on this?

Stephen Neeleman: Yeah, I want to also, George say that Jon stole my answer, just your question now. Now, but look, I think that as George, we’ve known you for now I’ve gone it nine years when we met you, right? And consumer — consumers have always been number one to us. And we’ve had questions that are similar to one you just asked, which is like, why do you always tell people about these investments when you make less yield on the investments or when you do on, on the cash? And the answer is because the consumer will always be number one in our book, and it’s because consumers need the help. And so one of the things I did talk to some legislators today about was where they stand on things. In fact, I gave an article from NPR to a senior senator today that talked about the variance one question you just asked and I asked him, what do you think about where we’re standing with these transparency requirements for hospitals and health plans?

Who are some of our great partners, hospitals and health plans? And it’s great to hear that there’s actually some bipartisan kind of girth behind getting consumers the right information they need to make better choices. Now, whether that plays out in the market where consumers just now have the ability to go get a lower cost of insulin because, the price drops by 75% because the new entrance, which happens to be one of our partners comes out with new insulin, that’s wonderful. Or if it’s it manifests itself a little bit differently that Jon was alluding to, which is, that there has been some progress as, getting consumers use your Jon’s word certainty on cost, for example, under the Affordable Care Act. Consumers, if they’re diagnosed with high cholesterol, they can get statins for free, right, with no cost share and so it’s certainty.

They’re helping pay for it. And obviously the health plans can negotiate very price on that. I think that there’s other opportunities out there and so as legislators have looked at it and said, how can we help people be more healthy? Is there, is there a way to help have better drug prices? Can we far away behind some of these initiatives? It completely benefits us. To your point, there may be lower upfront spend, but we’ve always said we’d much rather have people have more money in their health savings accounts longer, and then they can spend it next year. And, at some point they start getting older and the healthcare costs start to go up. The average age of cancer in this country is in the sixties. Those are going to be times when they really need to spend this money when they have those types of events.

And, and we’re going to be there for them and so, I think you will always find us completely comforted by expanding regulations to be able to do things like better transparency and lower cost drugs and things like that. So we’re going to keep doing that and we’re going to keep innovating to get people the right information at the right time so they can make the right choices with the way that they both save and invest and spend their healthcare dollars. And, let me say one more thing for those who are wondering like, what the hell this answer and question has to do with our revenue streams, there’re, in addition to the sort of more obvious answer that is, it makes the health plans that people choose and then choose to bring to us, bring dollars to us more appealing and can IFL there are also some more direct opportunities here.

Our clients at the employer level, our health plans and our partners at the broker level are absolutely, this whole discussion around bringing, it’s not — it’s transparency, but it’s also simplicity to some of the more routine pharma items to things like maternity to mental health where we don’t want people not using these services, not because they can’t afford them because they don’t understand what they cost and they’re scared. We don’t want to be in that circumstance. And they’re easy things that are relative to rocket science. There are easy things that can be done in plan design and that, that helping employers do those things and helping clients do those things and helping our partners arrange those things. There are interesting top line opportunities for us that right now we’re in the exploratory phase and seeing where we have the right to win and where, where we can partner with others and whatnot, but, this is an area of, of real opportunity for us.

Operator: The next question is from Mark Marcon with Baird. Please go ahead.

Mark Marcon: Hey, good afternoon and thanks for taking my question. I’ve got two questions. The first one is with regards to the number of HSAs that were added in in the fourth quarter, can you kind of break down both for the fourth quarter and for the year the percentage of new HSAs that were a function of brand new sales to new employer partners versus what percentage was, was due to new hires and to what extent may have the new hires slowed down in the fourth quarter relative to earlier in the year?

Jon Kessler: Yeah. So let me without you always ask questions in a way that I’m not going to answer them exactly that way, but I’ll do my best. If you look at it, and you will notice on year over year basis that the, that we were, we were ahead in earlier quarters of the year, but as the year went on, right, in terms of new ads, right, we were closer to last year, I think in Q4. We actually had more new ads in the prior year than last year. And someone could bang us on that except that we said throughout the year that that again, particularly at the beginning that, hey, part of what was going on here was new, was essentially job formation, right? And job formation, as did slow down a bit in q4, particularly calendar Q4 and relative to earlier part of the year.

And so I think that was reflected a little bit the, the sort of and so that was reflected a little bit in the data and then again of the commentary, man about guidance, right? We’ve tried to be, I think very realistic about, we look forward, let’s look at, let’s guide with the idea of a neutral view of job creation, right? Neutral doesn’t mean zero, it doesn’t mean negative number. It means more neutrally a hundred thousand a month, that kind of thing in terms of what the broader economy is doing. So that there is the connection there, Mark, that you’re, that the question implies that having been said across both HSA and our CDB business new logo and new client within existing health plan and, and retirement record keeper partner was a very important part of this year.

We looked at and what’s nice is today is that more of your new logos are actual in the HSA world are HSA takeaways. Of course in our world, many of those are also cost sales. We have existing products with them. Some of the folks that, if you look at the case studies that we talked about over the course of the latter part of this year, Pfizer being an example, right? That’s an example of a company that never offered HSA. So there’s those — but then there are also examples of like, they were offering it, right? They weren’t satisfied with a partner that was really looking at it from the perspective of the needs of every member. Maybe just looking at the, the top 2% or just looking at a way to just pay healthcare claims without regard to how they could help, the consumer.

Either way we’re a better option than that. And so that’s the takeaway business. So I it is probably a fair statement to say that in the earlier part of the year, right existing basically employment growth at existing firms was a bigger component than in prior years. And that kind of normalized itself as we got towards the end of the year. And, you continue to gain share and you continue to win more and more than your fair share. So I think that’s fairly clear. I was just trying to dimensionalize what the over year trends were looking like. The relevant point is when people go into next year and now this year and they say, oh, you sold almost a million HSAs, is it going to be million one? I kind of say the same thing when, when last year people said, you’re going to sell 900, you’re going to sell a million.

And, if I rewind a year ago, we were not thinking that we would have the level of robust employment growth over the course of calendar 22 that we actually did. And so we were — got, we were sort of trying to point that out to folks and I’d make the same comment this year, just starting from a slightly different point. And I think, and I think people are more on board with the idea that employment growth is going to have to moderate from here. The government seems to want to make that happen, but it’s, it’s kind of the same point,

Mark Marcon: Right? And then the second follow up question is basically was really nice to see the gross margins improve on the service line and on the interchange fee. I imagine a large part of that is due to the integrations. And I’m wondering if you can, talk at a high level in terms of what the implications are on a go forward basis, because that was that was really nice improvement.

Jon Kessler: Well, I’m going to focus on service and I think they’re, Mark, the truth is we have work to do. I’m not — I appreciate that, on a year-over-year basis, we boosted what you might call, service gross margin by 11%. That’s also because the year, the prior year just sucked. My life, I don’t have to say that. And in my view, we still have a ton of work to do here. What’s interesting and important and, and for those who are close observers of our hiring and so forth, what you’ll see is that that there’s some of that work that’s very, I’m going to call it, commercial and operational. So, as an example, there are some areas that now that the dust has settled from the pandemic, that there are fees that we have to look at and we have to be paid reasonable fees for reasonable work.

So, there are elements for example, the Cobra business that we’re looking at and working with our partners and saying, guys, here’s how this has kind of sorted out, right? Things are different than they were pre pandemic. Let’s address that. And obviously labor costs have risen too, right, but there also is a ton that we have done and can do with tech. And I’m going to give you one example, and like, I’m not going to I don’t have a chat GPT story to share with you, so you can be relieved in that regard. I’m not going to try and suggest that we ginned up some initiative in that area, but what is true is that if you look at our volumes during peak, our peak month, which is January, right? We, and the team just delivered an outstanding month. And part of the reason that they were able to do that is that chat handled, not chat GPT, but our chat functionality handled, I don’t know, 30% more calls than it had the prior year.

And part of the reason that makes things easier is because it turns out that chat is more effective at inserting, I’m not going to call it AI, I am going to call it computer generated answers. Then you can do in the context of an IVR or the light. And so it and there is a lot more juice to squeeze there and plus, which our, our members from the perspective of SAT have loved that stuff. And so, it does to some extent reflect the kind of changing demographics of the membership. The highest uptake rates of HSAs are among millennials and so, that’s a bigger part of our base. They want rapid answers, they get them, but I do think on the — we tend to talk about tech from a revenue growth perspective, but there’s also a ton of opportunity here. And, I guess, I really, I don’t want to convey in any way, shape or form genuinely like that we’ve accomplished much of anything other than we, we didn’t make the same mistakes that we made last year.

That is back in the, the rollover and we didn’t have the same, macro environment of remember Omicron or whatever, Greek letter we were dealing with. So I don’t think we’re like at pat our back on the sales on the back level here. We’re at a place where we’ve got more we can do

Mark Marcon: Thank appreciate. Might have you mind if I just tap for one thing and just talk May maybe just come out on the service level though. Even though we pat on that back for just a second because we did, I think, I can tell you that was great. Go ahead though.

Jon Kessler: Yeah, no, look I think at some level for everything we try and do, the table stakes in our business is that when our clients, particularly our smaller clients, call us up in the middle of January with something going on that we can help them and we can help them quickly and that was a challenge in January of 2020, calendar 2022. And it was, it’s always a little bit of a challenge because everyone called same time, but far less so. And that was both the work of our team, the work of our partners in getting clients loaded and then the work of our operations partners sort of our word for vendor in doing their thing. So and it’s going to help us from a sales perspective already is helping us from a sales perspective as we get into this year.

Steve alluded to, and we, we’ve tried to get away from like quoting RFP staff, but Steve alluded to some of them and like, look, the truth is a lot of that is people are like, okay, you just helped me out of a jam that maybe I created in January, right? I’m going to remember that when it comes time to do my next, RFP for something in February. So like again, it’s obviously a very uncertain time, but it’s, this is one of the reasons why we felt comfortable with the idea that we could do what we thought we would be able to, which was come here in March, raise our guidance a little bit, just as if as if nothing had happened in the last few weeks. And obviously something has happened and yet, we feel like we’re in really good shape here.

Operator: Thank, thank you. Our next question is from Allen Lutz with Bank of America. Please go ahead.

Allen Lutz: Thanks for taking the questions. Jon, you mentioned chat as an area where you’re spending tech dollars, and I think I asked a similar question last quarter, but as we look at the tech and development line, obviously that’s gone up pretty dramatically over the past few years. Can you talk about in fiscal ’24, your expectations, obviously you’re going to be spending on things like chat and other things, but is that going to scale as a percent of revenue in fiscal ’24, or should we expect that to continue to de-lever as a percent of revenue this year? And then can you talk about kind of what’s driving that outside of chat, if anything? Thanks.

Jon Kessler: Yeah, and maybe I’ll invite Tyson to correct me if I’m being imprecise or if I’m going in the wrong direction here, but this is going to level out and it’s levelling out as a percentage of revenue because really because expenses that, we’re really, if you look at it, we’re integration expenses are now are either not necessarily or being used for innovation. And so, there are some things that muck around with it. Like, as you well know, as we’re now well into cloud world you get less D&A, which the good news is you get more free CLO free cash flow conversion, right? But the bad news is that from an EBITDA perspective, it doesn’t, doesn’t look as good, blah, blah, blah, all that stuff. But, I your intuition, which is that this is levelling out is correct and it’s and then it’s really about what’s really important is not just that it levels out, but rather, and then I think ultimately, begins to decline as a percentage of revenue.

But that it’s what we’re spending it on because in real dollars, this number’s going up and what’s important is the shift in that expenditure from the process of integration, which was really important for us to get us to where we are today to now, shifting those dollars towards really focused on our core growth platforms and our innovation on those core growth platforms. And if you look anyone who looks at, LinkedIn or any of these things that they can see exactly what’s happening and that is what’s happening. I just want to give Tyson a chance. Did I answer that in the way you would have?

Tyson Murdock: You did great. I guess the only thing I would ask, I’d just say the way we build plans is we try to get leverage off those P&L items, P&L items, even when you think about stock comp and things like that. So that’s a priority for us as a business to make sure that we’re for all of our leaders. So, that’s my mention.

Operator: The next question is from Stephanie Davis with SVB Securities. Please go ahead,

UnidentifiedAnalyst: Hey guys. This is Anna. Thank you.

Jon Kessler: Oh, I don’t like the sound of that, Anna. Go ahead,

UnidentifiedAnalyst: So first I actually wanted to go back to the more elevated R&D spend on the platform. You did mention that should start to level out, but curious if you could give any sort of outline on how you’re working to modernize the platform?

Jon Kessler: Yeah. You want to give your second part too, and we’ll try and hit both together.

UnidentifiedAnalyst:

M:

A:

Jon Kessler: Yeah, awesome. That’s perfect. So what we’re really focused on, and I expect for those who, I don’t mean to like build it up crazy, but for those who attend our investor day, we’ll talk a little more about this and, and we’ll bring some more people to talk about it. But, we’re really focused on the view that within, broadly defined the world that we operate, which is, is, ultimately about helping people, we say connect health and wealth, a longer version of that is to help people manage the financial aspects of their healthcare. There’s the evolution of technology, the, the incremental use of APIs, obviously some of the AI stuff it creates some new opportunities that I think did not, we think didn’t exist four or five years ago.

And some of it is the existence of the tech and some of it is the embrace of the tech by everyone else, by others within the ecosystem and so that’s really where we’re investing. And I talked earlier in the year at some other some other banks conference about some of the specific opportunities both in that we have here to drive both new product that that’s very visible to our clients and members as well as, drive things in the area of the transaction or card fees around really integrating what we do into the existing mobile wallets making some of that stuff easier and ultimately driving incremental transaction value. So that’s really where we’re focused in terms of, of where those dollars are going as well as the basics of completing our cloud journey and all those kind of things.

But, I think, my take here is that we have this period of time where all of the things we’ve done from expanding the product set through, the addition of wage and all of that, expanding our partnership base through things like the further acquisition enhanced rates. And the migration of that over the course of the next few years, plus, notwithstanding events over the last few weeks, what is still a far more favourable environment, from a macro and rate perspective, this gives us a period of time where we can both invest in these kinds of innovations that will produce growth over time and still in the near term, deliver to you as we’ve done in our outlook here incremental pre material, incremental margin improvement. So to the second part of your question, is it plausible that you know that, that some M&A is a piece of that?

And the answer is yes. I think it will — it’s far more plausible that it would be in the nature of smaller, enterprises where it’s a little bit more like, aqua hire or the like, as opposed to existing three, $400 million businesses. And I say that it’s not impossible. I say that because that’s where I think the opportunity is for us and for created value for our shareholders. Right now, I don’t see the same one, I don’t see the same level of rationalization within those established businesses yet. And two that’s our clients are, especially in, one of the reactions to inflation and like, our clients want more solutions that help their consumers navigate the financials of healthcare, right? And we already do what’s great in that space that’s established.

It’s about, some of the new stuff that’s out there and are there examples of folks who are out there, and able to try stuff as effectively R&D labs and, we’ll be happy to do that kind of stuff, but it’s not going to — that’s not going to be like, big draws on the balance sheet or the like, it really is, build versus buy type discussion on some of those things.

Operator: This concludes our question-and-answer session. I’d like to turn the conference back over to Jon Kessler for any closing remarks.

Jon Kessler: Man, you really cut that off. That was like — that was Richard quality there. Thank you. Can, we have you at every call? No. so thanks everybody. Look obviously, I hope what you have taken from today’s call is that we really feel, now having, being a full two weeks into this current, craziness, that if we’re able to step back and look at it from the perspective of the long term of our business, this demonstrates the quality of what we do and the value of having a plan and sticking to it. And ultimately the steadiness of our business, which has always been one of the things we have promised you that is to say visibility, along with growth, which we’re delivering with our outlook, profitability which obviously we’re delivering with our outlook.

And then durable competitive advantage, which as someone pointed out in the Q&A, is ultimately a function of extending our market leadership. So hopefully, we’re doing what you want us to do and hopefully that’s, we sort of believe we will get rewarded in the long term for that. And in the meantime, we appreciate everyone’s questions, everyone’s interest, get your Bermuda shorts now before they’re spring priced. And we’ll see y’all in — we’ll talk to you before then, but we’ll hopefully see y’all in Utah in the month of July.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.