Healthequity Inc (HQY) 2016 Q4 法說會逐字稿

Good day and welcome to the HealthEquity fourth quarter and full year 2016 results conference call. Please note, this event is being recorded. I would now like to turn the call over to Frode Jensen, General Counsel. Please go ahead.

Thank you, Ann. Good afternoon and welcome. My name is Frode Jensen and I am General Counsel of HealthEquity.

Please be advised that today's discussion includes 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. Those forward-looking statements are also 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 would encourage you to review the risk factors detailed in our annual report on Form 10-K filed with the SEC on March 31, 2015, and any subsequent periodic or current reports for a discussion of these risk factors and other risks that may affect our future results or the market price of our stock.

Finally, we are not obligating ourselves to revise our results or publicly release any updates to these forward-looking statements in light of new information or future events. With that, I will turn the call over to Jon Kessler.

Thank you, Frode, and thanks, everyone. Welcome from wintry Salt Lake City. I'm joined today by Darcy Mott, our EVP and CFO, by Matt Sydney, our EVP for Sales and Marketing, and by Steve Neeleman, our Founder and Vice Chairman. Darcy, Matt and I will have some prepared remarks, and then all four of us will be available to answer questions. Here we go.

HealthEquity delivered another strong year of results in the four key metrics that drive our business, which are revenue, adjusted EBITDA, HSA members, and assets under management, or AUM. For the FY16, we recorded revenue of $126.8 million, an increase of 44% compared to FY15, adjusted EBITDA of $40.6 million, which grew 61% compared to FY15, once again outpacing revenue growth; and as we announced in February, HSA membership reached 2.1 million, up 50% year-over-year, and AUM reached $3.7 billion, up 56% year-over-year.

As we discussed with you in our call in early February, we had a phenomenal fourth quarter in terms of new accounts and AUM increases. Financial results were equally strong. Q4 revenue of $35.9 million and adjusted EBITDA of $8.9 million were up 44% and 61%, respectively, year-over-year, despite record onboarding activity. These results set us up for a strong FY17, which Darcy will talk about in a few minutes.

You know, almost exactly two years ago today, Darcy, Steve and I began speaking to public investors about HealthEquity in advance of our IPO. We said back then that the HSA opportunity, the opportunity on which we uniquely focus as a business, was in its early innings.

We said HealthEquity's addressable market would grow in excess of 20%, driven by the fact that HSA-style health plans and HSAs, combined with support for consumers to spend and save wisely for healthcare, make a better system for all of us. And it happened. According to Devenir, market-wide HSAs grew by more than 20% in each of the last two years.

We also said HealthEquity would outgrow the market, through adding network partners, adding new accounts by penetrating existing network partners, and growing AUM as existing accounts mature. All of those things also happened. The network partner base grew from 197 back then to 513 at the end of FY16. Nearly all network partners saw increased penetration, such that HSA members overall grew from 970,000 at the end of FY14 to 2.14 million at the end of FY16. AUM grew even faster, from $1.6 billion to $3.7 billion over the same period.

We said we would expand the market opportunity by participating in consolidation as banks exited the market and by growing our ecosystem; and we completed two competitive acquisitions from financial institutions this year, and we've built an ecosystem that now boasts over 1,400 data connections, increasing the defensibility of HealthEquity's competitive advantage.

So put simply, we've tried to deliver on what we said would happen. And finally, we said we would build on a platform that had already proven its scale and profitability, and that, too, happened. HealthEquity added 330 basis points of adjusted EBITDA margin in FY15 and another 331 basis points -- that's one more basis point -- in FY16, finishing the year with an adjusted EBITDA margin of 32%.

The thing is, two years later, we are still in the early innings of HealthEquity's opportunity. And there's really no better evidence of this than the results our sales team and our network partners are putting out. To talk about that, here is our Executive Vice President Matthew Sydney, from an undisclosed remote location. Matt, go ahead.

Thank you, Jon, and good afternoon, everyone. As Jon mentioned, this was a great year for HealthEquity and I want to spend some time this afternoon discussing our strong organic growth throughout FY16 and the significant runway ahead of us.

First, our robust ecosystem proved a competitive differentiation and it's helped us significantly expand our footprint of our network partners. As we announced in February, our number of network partners increased from 51% from 340 to 513 in FY16. Our large employer network partners grew by 163, or 60%, and our health plan network partners grew from 70 to 80 health plans.

These additions include partners from across a diverse set of industries and locations, from one of the nation's premier retailers based in the middle of the country to a leading Wall Street firm. From a modest-sized health plan in Texas to multiple Blue Cross and Blue Shield plans, all of these partners being very savvy and experienced buyers challenged our thinking. Having had accounts with prior custodians, they were all very aware of the basics of consumerism and were ready to take their programs to the next level.

In fact, most of our new network partners are not entirely new to HSAs. HealthEquity's experience in delivering the highest level of customer service, our corporate stability, and our industry-leading engagement strategies were all core to why these organizations are now partnered with HealthEquity.

This diversity has another important benefit to HealthEquity. Our concentration with any one network partner remains very low. As of January 31, no network partner accounted for more than 7% of HealthEquity's HSAs. Contributing to this is the fact that many HSA members stay and grow their HSAs with HealthEquity even after their affiliation with the network partner ends.

To expand on the idea of our continued competitive advantage, I want to provide some additional commentary on our HSA member and AUM growth. As Jon noted, HealthEquity grew members, HSA members and AUM, by 50% and 56%, respectively during FY16. According to Devenir, during the calendar 2015, our top four competitors grew HSAs by 24%. In the top 20 custodians, excluding HealthEquity, grew HSAs by 26%.

Second, while we're very pleased with our penetration of the market up to this point, there is still a tremendous opportunity ahead of us. By our estimation, roughly 72 million Americans under 65 receive health benefits from HealthEquity's network partners. Based on that estimate, we remain single-digit penetrated in our current network. Nearly 66% of our network partners have been with us for less than two years. We see plenty of room to expand with them.

We've found that given the stickiness of HSA members, adoption almost always trends up over time, as our relationship with network partners matures and HSA qualified health plans are made more attractive relative to the other plans in terms of premium, employer contribution to the HSA, and other plan design factors. And of course, some large employers have gone to 100% HSA qualified plans, what we refer to as full replace.

In an effort to drive further penetration within our employer network partners in FY17, we've recently added highly experienced and consultative account executives focused on this very issue. These account executives build great relationships with our partners that allow them to better assess their readiness and also provide them with the necessary tools for successful expansion of HSAs. Our highly experienced account executives leverage client-specific, industry-specific and market best practice data to consult and help maximize our network partners' programs. We believe the combination of our customer engagement tools and the addition of these account executives will generate higher penetration levels within our network partners over time. Ultimately, we've demonstrated strong organic growth over the last year and the notable increase in network partners positions us very well for continued growth going forward.

I would now like to turn the call over to Darcy Mott, our Executive Vice President and CFO, who will review the details of our fourth quarter results and guidance. Darcy?

Thanks, Matt. Today I will discuss our results on both a GAAP and a non-GAAP basis. Our non-GAAP operating metrics include adjusted EBITDA and non-GAAP earnings per diluted share. We define adjusted EBITDA as adjusted earnings before interest, taxes, depreciation and amortization, non-cash stock-based compensation expense, and other certain non-operating items.

Non-GAAP earnings per diluted share is calculated by adding back to net income all stock-based compensation expense, net of tax, and then dividing the result by diluted weighted average shares outstanding. I would like to use my time today to review our FY16 full-year and fourth quarter results and to discuss our initial FY17 guidance.

Let me start by saying that we closed the M&T Bank HSA portfolio acquisition during our fourth fiscal quarter; however, the custodial transfer was not completed until March 11, 2016. We paid approximately $6.2 million for this acquisition and added approximately 35,000 HSAs and approximately $63 million of AUM. The acquired intangible assets will be amortized over 15 years.

The M&T Bank HSA portfolio acquisition had no impact on our fourth quarter FY16 or full-year FY16 financial or operating results. It will be included for approximately half of our first quarter FY17 results.

As Jon mentioned, revenue for FY16 was $126.8 million, an increase of 44% compared to FY15. At HealthEquity, we report revenue in three categories, service revenue, custodial revenue, and interchange revenue. We have revised certain financial statement line items to more accurately describe our operations.

Amounts previously referred to as account fee revenue are now referred to as service revenue. Amounts previously referred to as custodial fee revenue are now referred to as custodial revenue. Amounts previously referred to as card fee revenue are now referred to as interchange revenue. Amounts previously referred to as account costs are now referred to as service costs.

Revenue grew substantially across all three categories during FY16. Service revenue was 49% of total revenue, at $61.6 million, representing an increase of 35% compared to FY15.

Custodial revenue represented 30% of total revenue, at $37.8 million. This represented an increase of 55% compared to last year and an average cash yield of 1.57%. And interchange revenue represented 22% of total revenue, at $27.4 million, an increase of 55% compared to last year.

As we announced in February, our investment AUM as a percentage of total AUM at the end of FY16 represented 11% of our total AUM, which was down from our 14% in third quarter of FY16, partially due to the inclusion of the Bancorp assets, which have a much lower investment rate. We plan to target those accounts and assist account holders in transitioning to investment accounts, where appropriate.

Gross profit for the year of $72.6 million, compared to $48 million last year, an increase of 51%. Gross margin for the year increased from 55% a year ago to 57% in FY16.

Income from operations of $26.1 million during the year increased 55% year-over-year and generated an operating margin of 21%, compared to 19% in FY15. We generated net income of $16.6 million for FY16, compared to $10.2 million in FY15.

Our non-GAAP adjusted EBITDA for the year was $40.6 million, compared to $25.2 million in FY15, an increase of 61%. Our GAAP diluted EPS for FY16 was $0.28, compared to $0.21 a year ago. Non-GAAP diluted EPS was $0.34 for FY16, compared to $0.23 for the prior year.

We were very pleased with our fourth quarter performance, as well. Revenue of $35.9 million in the quarter increased 44% compared to the fourth quarter of FY15. Adjusted EBITDA of $8.9 million in the quarter increased 61% year-over-year, and GAAP EPS of $0.05 per diluted share compared to $0.02 in the prior year fourth quarter. Non-GAAP diluted EPS was $0.07 per share, compared to $0.04 per share in the prior year.

Turning to the balance sheet, as of January 31, 2016, we had a $124 million in cash, cash equivalents and marketable securities, and no debt.

I want to touch on one last item before discussing our outlook for FY17. Service revenue on a per HSA basis decreased by 8% in FY16, in line with our previous comments. We will trade lower service fees, which are typically paid by employers, for more HSAs with higher balances. Service revenue also includes revenue from flexible spending and health reimbursement arrangements, what we call RAs, which are complementary to, but are not growing as rapidly as HSAs. Acquired HSA portfolios typically have lower service revenues per HSA and typically no RAs.

Now turning to guidance. In terms of our initial outlook for the full FY17, we expect revenue between $170 million and $174 million, adjusted EBITDA between $56 million and $58 million, and non-GAAP diluted EPS between $0.45 and $0.47 per share.

Our non-GAAP diluted EPS estimate is based on an estimated weighted average share outstanding approximately 61 million shares and is calculated on and after adding back to net income all non-cash stock compensation expense, net of tax. We expect total stock compensation, net of tax, for FY17 to be between $5 million and $6 million. The business outlook for the year ended January 31, 2017 assumes a projected effective tax rate of approximately 37%.

Now I'd like to turn the call back over to Jon for his closing remarks.

Thanks, Darcy. A few final comments.

First, I'd like to invite our analysts, investors and potential investors to HealthEquity's first-ever investor day, which will be held in New York City on June 21. For more information regarding the investor day, I would encourage you to contact our Investor Relations team via our website.

Second, a special announcement. Our mission at HealthEquity is to get every American family an HSA, and also, the support to save and spend wisely and build health savings. We really believe that if this mission were achieved, it would help all of us pay less and get more from a healthcare system that is more responsive to consumers.

We get there, though, one step at a time. And we measure the steps by HealthEquity members assets under management, or AUM. That is to say, our member success at building health savings.

In 2006, when HealthEquity became an HSA custodian, we had under $20 million in AUM. It took us seven years to get to $1 billion in 2013. It took another two years to get to $2 billion in 2015.

Now, 14 months later, I am pleased to announce that we have eclipsed $4 billion in AUM. That's a fantastic achievement for our HSA members and their families, and a credit to the family of purple people at HealthEquity who have made it happen.

Finally, thanks, everyone, for joining the call. And now, let's open the call for questions.

(Operator Instructions)

Peter Costa, Wells Fargo Securities.

Good evening. Congratulations on the quarter. Very nicely done. A couple questions for you. Let's start with where you left off, with the $4 billion in AUM. It looks to me like you got some big transfers in again. It's hard to tell exactly, with the acquisitions that you did, but it looks like there were some transfers in. Can you talk about that, and then what that means for the Company?

Sure, Pete, and good to hear you. Is it snowing in Boston like it is here?

No, it's beautiful up here.

Well, that's good. We reported the $4 billion because that has been a significant target for the Company for the last couple of years, for us to get to that. And so when we crossed over that threshold, we thought it meaningful to announce it. We will announce the details of our first quarter AUM increases when we report on our first quarter. However, we know that your expectation is correct, that we did see some rollover activity in the first quarter of this year, just like we saw last year. And so we'll report more on the details of that in our first quarter call. But you're correct.

Additionally, as we noted, I think, in the release and Darcy noted in his comments, the M&T transaction is now complete and we received, obviously, a nice boost from that.

Right. And so Matthew's comments regarding more full replacement business going on and more of the members coming in having had HSAs previously, are we -- have we hit some kind of a threshold or inflection point at this point, where things are going to move much faster going forward?

Steve, do you want to comment on that one?

Yes, Pete. As we've looked at this closely in the market, I don't think we've hit the real inflection point. I think we're seeing just the large employers, the ones we track, the network partners, just marching along year after year. The nice thing is, as we look at the vintage ones that have been with us for four or five years, they start to get up over 50% adoption if things are lined up at their plan in time. But it's really a function of employers willing to put the money into their (inaudible) and direct it toward the HSA, both in deposits and premium savings.

Some employers don't do that. But the ones that are being thoughtful and willing to be able to do what's right for their employees, help them grow their health savings, and then also be able to save some money (inaudible) and things like that are doing it. But I do not think -- and I think the team would agree -- that we're at some tipping point where all of a sudden they're all going to go forward [flex].

Okay. In terms of going forward, looking the build up of your revenue for FY17 in terms of the three line items, how much more pressure do you expect there to be in 2017 on account fees per account? And it looks like you had a nice bounceback on the interchange fee this quarter relative to the third quarter, can you talk about, is that a steady trend or was there some kind of a movement of business from 3Q into 4Q?

Yes, Pete. First on the service revenue, as I stated in my prepared remarks, we had an 8% decrease if you calculate it on an average HSA basis. But as you know, we tried to point out there, there's three elements that really contribute to that. One is just the balance that we do when we go out and win new business, and even with our existing partners who are getting increased penetration with more accounts, where we believe that we will get more custodial revenue in the future. And so that has a little bit of a drag on that service fee per custodial account calculation.

Also, as I mentioned, the acquisitions that we did, they had lower service revenues per custodial account than we do; one, because they don't have any RA, and secondly, because they just had average lower balances -- excuse me, lower account fees. We saw a little bit of that impact in this year, but those accounts will be with us for the full year next year, and we don't have any anticipated price increases for them. We're trying to absorb them into our book as being HealthEquity members and provide the service that we believe we can offer to them. And so that explains what is going on with the service revenue. And then factoring in the fact that we make those decisions based on overall revenue per account.

With respect to the interchange, on our third quarter call we did mention that we had a little bit less spend than what we had expected, and the spend levels came back to what levels that we had previously expected in the fourth quarter. So yes, we did see the revenue come back up in the interchange bucket.

Okay. And then just the last question, have you had further inquiries from other banks, since doing the M&T transaction, about doing something similar with other banks?

Yes, so I would say -- well, obviously, generally we're not going to comment on M&A-related activity. We don't wait for inquiries. This is something that we try to have an active dialogue about with competitors who are potential partners. I would generally say that dialogue is as active as ever. And hopefully, we will have more to say on it as things progress.

Okay. Thank you and great quarter.

Thanks, Pete.

Lisa Gill, JPMorgan.

Thank you. Good afternoon. Darcy, let me start with a question for you. If I look at the general and administrative costs again this quarter, we're down versus our expectation, down year-over-year. Can you give us an indication as to is that just levering some of the cost basis so you don't have as much that you need to spend going forward? And how do we think about expenses playing out as we go into the next fiscal year?

Lisa, thank you. Can you clarify, are you talking about the revenue or the cost component?

No, the cost component of it. So if I look at your G&A, $3.5 million in the fourth quarter, again, we were expecting north of $5 million. I'm just curious as to how do we think about your cost structure as we move throughout the next fiscal year.

Got it. Got it. So overall on OpEx, we expect there to be leverage over time. We've demonstrated in the past that we've had some leverage in sales and marketing. There's a couple of things that go on. If you think that we had 44% increase in revenue and 61% growth in EBITDA, obviously we're leveraging both in our gross profit margin and on our operating margin.

There's a couple things that go into that OpEx line that take away from that. One is stock comp. Stock comp is up higher as a percentage than what it has been in the past. And then capitalized -- amortization of capitalized development costs. We capitalize that and then we amortize it over three years. So we've had a fairly intensive level of increasing our CapEx spend in that regard. So that's hitting into that amortization -- or operating expense line. And then the third item that we've had has been just transitioning from a private company to a public company. Last fiscal year, we had about half of the year in, this year we've had a full year of it. Plus we've crossed over the barrier, so we had to become Sox compliant as of January 31, 2016, which we've done. So we're moving in that area.

So that accounts for the increases that you've seen in technology and development and into the G&A line. But as we continue to grow, we think there is still some leverage opportunity there. It's just been masked a little bit, because of the nature of our increases that we've had in the last two years.

Okay. That's helpful. And then secondly, I think Steve talked about 72 million members that have high deductible health plans, so you're single-digit penetrated. Can you or Jon or Steve maybe talk about the progression of bringing those people into your HSAs over time? How do we think about that penetration rate and expanding that penetration rate over the next several years?

Yes, Lisa, thank you. It's a great question and it's always good to hear your voice. I think the important point for everyone to keep in mind is that -- well, let me go back. First, the most important point to keep in mind is that I think our industry as a whole, in its first five, six, seven, eight years of existence, when it really was dominated by very conventional financial services firms, really underestimated the magnitude of this transition for real people. And it thought, well, we went from defined benefit pensions to 401(k)s, and that seemed to work out, so we can probably do this, too. And perhaps what it forgot about is the immediacy of healthcare-related decisions. And so to some extent, that fact is what accounts for our growth. That is to say that both through service and through technology, what we try to do is, as best we can, is to address that fact for our members and for our partners.

That having been said, the reason I start the answer that way is to say that we don't view penetration, or uptake, as it were, as fundamentally a matter of marketing. Though clearly that can help, education can help and support, right? We view it as the best thing we can do -- and Matt referenced this in his comments -- is to take advantage of the leadership role we have in the business and spread best practices. So given that we are among the largest players in the business and certainly the largest focused player in the business, we feel like we have unique insight to give about what's working, working in this case being defined as American families making this transition successfully. And I think the more we do that, the more we can drive that uptake.

But ultimately, it's going to be a function of that advice and other factors translating into decisions that employers, health plans and, ultimately, individuals make about the underlying health plan itself. And so when an employer decides that it's comfortable with, for example, adjusting prices so that the HSA is on a more even playing field with other stuff or a more favorable playing field, then you get more adoption. And so that's the way we look at it. We don't look at it like, well, if we've had a partner five years, they should be at X.

What we do, however, get a lot of comfort from is the simple fact that we look at this partner by partner, over 500 of them now, and not without exception, but with rare exception, they always move in the right direction. And so year after year, we see with given partner -- we will see more uptake than we saw the year before. And so that's a good thing. But it is a little hard to think through some dramatic measure that one could or should take or some dramatic environmental factor that's going to move that activity beyond the measured pace that it should have -- measured, in this case, being roughly 20% market growth.

And Jon, I know I've asked this before, but just to that point, the potential push out of the Cadillac tax, is that changing the timeline of any of these discussions moving towards high deductible health plans?

No. I think the way we have talked about this in the past, and certainly this has borne itself out as we begin a new sales cycle -- that's sort of funny -- whenever we announce the last one, the new one is already well underway -- and as we begin that new cycle, what we're seeing is the exact conversations we would have expected based on the underlying economics of HSAs and HSA-style plans. They save people money. They take the edge off the cost curve, so you're not stealing from wages to pay benefits. And they get people engaged, which can also have other benefits. And when done right -- and that's what people are talking about, and that's what we expected them to be talking about. So we haven't seen any fundamental change in the volume of RFPs or anything along those lines.

Okay. Great. Thank you.

Sandy Draper, SunTrust.

Thanks very much and congrats on the quarter. Maybe first question for Jon and/or Steve. Any noticeable change in terms of the competitive landscape in terms of not necessarily a specific competitor, but more or less from the banks, more or less from the HSA inside of health plans, more or less from other independent HSA providers, just any broad thoughts on that would be great. Thanks.

Matt, would you like to comment on this?

Sure. Sandy, thank you for the question. I think the best way to think about this is the competition is going to continue to advance. They're going to upgrade their services and their products. A lot of these advances are in areas that HealthEquity has pioneered. And really from our perspective, all boats rise with the tide, and we're really validating our approach as we continue to further our service and product advancements, as well.

So additionally, we'll continue to see, obviously, market consolidation. But from a dynamic standpoint, we're going to continue to push and optimize our network partners every day. That's what we work on doing. So from a competitive standpoint, we see that competition's tough. But I wouldn't say there's an incredible amount of change there. It's just the whole market is getting better, and as we continue to do so, as well.

I think one thing you see, Sandy, too, and you see this if you start to look at the data on where growth has been relative to the overall market and where people have underperformed or where they're just rising with the tide, it feels to us like -- and certainly, this is our objective -- that at some level, there's a level of table stakes that you need to have to play in the part of market we play. And I'd say five years ago, that table stakes was -- or 10 years ago, was account administration. 10 years ago, it was can I legally be a custodian? Five years ago, maybe it was, can I effectively manage an account? I think today, it's beyond that.

People are looking for expertise in employee communication, they're looking for robust offerings on the investment side, and of course, from our perspective, looking for you to really being able to integrate with the broader benefits offerings. And I think you can do whatever you want on the things that you can control. But I think the reality is, if you don't have the capacity to offer those things, either because you don't own or control your platform, or you're not prepared to make the investments to make that happen, or you haven't made those investments and so you're behind the learning curve, I do think it's tougher.

And it may be even tougher for people to recognize they're in that position, because a rising tide does lift all boats. But I think that's the underlying factor is, is for us to be competitive over time, it's really about, we've defined and we will continue to redefine what table stakes mean in this business. And I think it's going to be hard for a lot of folks to keep up with that.

Great. That's really helpful from both of you guys. And that actually leads into my second question, then I'll jump back in the queue. I think it was two quarters ago when you guys mentioned the higher level of investments and at the time, you said you didn't really want to go into anything specifically. Are you willing to talk about whether the new technologies and new enhancements, the -- anything that you're specifically -- where the product R&D money is going, or is that still something you want to keep under wraps for competitive reasons? Thanks.

I appreciate you giving me that option. I noticed we have some of our competitors on the call, and I presume that's because they've invested in the Company as part of a prudent retirement strategy. But we don't generally have a lot of product discussions on these calls, and I'd prefer not to. Certainly, something we'll go into some depth when we have our investor day in June.

Okay. I can appreciate that. Thanks, Jon, and congrats again on the quarter.

Thank you.

Steven Wardell, Leerink Partners.

Thanks. So my first question is, what's the latest on what you're hearing from network partners? Are they looking for changes in offerings? What are the trends you're seeing from them? Do they see greater member engagement?

Steve, you want to comment on this one?

Sure, it's a great question. I think you nailed -- or hit part of the nail on the head. They do want the engagement. As you know, Steve, there's been a tremendous investment in what we would call the ecosystem of this consumerism, including things like telemedicine and transparency and wellness and second opinion and all this other stuff. And the challenge is that I think a lot of our network partners are wondering, are they getting the ROI? So they are asking about engagement.

As we've pointed out in previous discussion, we do have a pretty remarkable engagement level, with, depending on the month, between 28% and 30% of our members coming to the website. And we're now getting increase in use of our mobile app and things like that. And so we're starting to do some really nice campaigns where we'll direct people through engagement that have come to our portal into some of these other tools, and we feel like our incentives are aligned, because if people do a better job of investing and contributing and then ultimately spending their money, that benefits us and benefits the network partner and it absolutely benefits the member, or the account holder, and it obviously benefits some of these other ecosystem partners.

So that's something we've done quite a bit. Pretty exciting stuff. But engagement is a big word. And I know it's a little bit of a buzzword, but the fact is it comes down to giving people the right information at the right time to help them make a better decision then. So that's something that we think is very important.

Great. Thank you. And then building on the discussion around account fees, I think there's some concern that some players in this market might be willing to be more competitive on their account fees, lower their account fees. Are you seeing that in the market, and how does that affect HealthEquity, if that is happening, going forward?

Yes. So Steve, thank you for that question. First of all, it's a great question. And what would be really great is if our competitors put their fees or any information about their fees in SEC file documents, like we do. But as I don't think that's in the offing, it is a little bit difficult to have a detailed discussion on where people are on their account fees. I'm going to try, anyway.

First of all, as Darcy mentioned in his comments, it is worth noting that what we call service fees are one of three pieces of our revenue stream. And when we underwrite a case, we underwrite the whole case. And I think, very frankly, when our partners look to buy, they look at the value of what they're buying. And as I suggested a few minutes ago, and as Steve talked about with the comments on engagement, and certainly Matt talked about, we don't perceive today that we have partners out there who are making decisions based on some difference that's modest in service fees. Of course, employee have to care about -- who are mostly the ones who pay them -- have to care about them, and they should. And of course, we have to deliver value.

But this wave of price cutting that some people are talking about, either we're not seeing it or it's not being taken seriously enough for our partners to care about. What they do care about, as we've said before, is our partners recognize that to the extent that they are able to deliver to us real volume in terms of accounts and assets and so forth, that we have the ability to underwrite that whole set of fees, as well as the interchange, and that allows us to gain share with our partners in one form or another, and that's a good thing.

But that's what we're seeing out there in the marketplace. Perhaps others have a different view about their ability to attract customers with price in the absence of other things they might have. But that's more or less how we see it. Darcy, anything to expand on that?

Yes. I think we've historically said, Steve, that we have modeled this component of our revenue on a unit basis to decrease about 5% over time. Some years it may be a little bit more than that, some years it may be a little bit less than that. Some of that is a result also of, as we've said before, of our partners getting to a higher volume and they have a tiered pricing structure that results in a lower price to them. So when they reach that cliff and they go down to a lower price, then that is reflected in our model. But our guidance includes all of that assumptions that we've made. And I think it's very consistent with what we've said in the past.

Great. Thank you.

Randy Reece, Avondale Partners.

Good afternoon.

Hello, Randy.

If I look at the third and fourth quarter of this year compared with the same periods of last year, custodial revenue was 30% to 31% of total revenue in the third and fourth quarter this year. It was 28% to 27% in the last two quarters a year ago. That's a pretty big increase. And I'm wondering in your guidance for revenue for 2017, do you expect that percentage of revenue coming from custodial revenue to continue to increase?

Yes. So without getting into specific guidance on revenue lines, you're exactly right that over time, account fees -- excuse me, I'm going to use the new -- service revenue as a percentage of total revenue has been coming down, and custodial revenue has been going up, as has interchange. So we would expect that those trends will continue.

I was surprised at how good the custodial revenue was in the fourth quarter, just in relation to the changes in AUM and the number of members. Was there anything unusual that caused that sequential increase in custodial revenue this quarter, other than those factors?

Well, remember that the Bancorp transaction, even though we closed it in October 23, we brought those custodial assets onto our platform in December. But they yielded custodial revenue throughout the fourth quarter for us. So that would have been -- without our installed base, that was also a differing factor that created that revenue. I know that when we talked about the timing of Bancorp, that we probably could have done a better job of helping you guys understand exactly when that revenue would pop in. But that was the thing that happened in the fourth quarter that fueled that.

The other thing that happens with respect to custodial revenue, particularly in the fourth quarter, is that even though it's only a one-month effect, we had a tremendous increase in custodial cash from Q3 to Q4, notwithstanding the Bancorp transaction. And that money comes in, generally employers like to get it deposited into their accounts, so we get a lot in in the first few days of January. We get some more big increases in mid month when payrolls hit, and also at the end of the month. So that -- but that's true every fourth quarter, that we have that bump in custodial revenue in the fourth quarter due to that phenomenon.

I think this also speaks to a little bit, Randy, the sturdiness of our depository relationships and always wanting to be thoughtful about this and never wanting to pat oneself or one's team too much on the back. The fourth quarter is the part of the year where one thing that we do all the time really pays off for us, and that's really try and have strong visibility to what cash flows will be like, when they will show up, when they will not show up and so forth. And that really takes the whole Company, because it requires all the way from timing of payroll contributions from given employers to the timing of onboarding and so forth, so it's really an effort across the business.

And during this period, this is happening daily. And the result of that is happier depository partners, because, think of that relative to your basic, large corporate depositor who just -- this isn't their job every day. And they're not going to provide that kind of visibility, and we do. And we've been doing it for a long, long time, and so people have grown to count on that and we, to some extent, get rewarded for that. I do think this speaks to the benefit of having a diversity of those relationships and really making it our business every day to connect what we see coming in as deposits to the potential use of those funds by our depositories.

Very good. Thank you.

(Operator Instructions)

Mark Marcon, Robert W. Baird.

Good afternoon and congratulations on a great year. Was wondering if you could talk a little bit more about some of the investments that you're making behind more account managers that Matt was talking about earlier, and what sort of impact you would expect that to have in terms of either more employer network partners or pace with regards to bringing on new accounts?

Matt, do you want to speak to that?

Sure. Mark, thank you for the question. And so Mark, to get to the heart of the answer, I think it's our focus on the account executive function, as I mentioned in my prepared notes, is really for us to begin to help our network partners, the new ones and obviously the ones that have been around for quite some time, is really to bring best practice to the table. To help them, if they are a health plan network partner, to win in the market and be more successful, or if they're an employer partner, to help them optimize their program. Really putting them in a position, by providing information and education to the employers themselves around, what's working, what works for companies that are like theirs, what works for companies that might be in the same [region], to help them better plan for the future for both activities and changes. And we feel this is the best approach to new sale.

Got it. And how would you compare the pipeline that you're looking at this year relative to last year, given the strong success that you're seeing and obviously the increased adoption? I would imagine it's significantly larger.

Mark, our pipeline continues to grow. This is what these folks do all day everyday. And obviously, they are very good at it and they intend to continue to get better at it every day. And that's what we work at. We don't rest on our laurels. There's certainly a lot of opportunity out in the marketplace. And as I had mentioned in the prior response to a question, the competition continues to get better and we continue to get better. So putting our best foot forward on a daily basis is really critical to us. And it's taking that pipeline, year-over-year, continuing to grow it, to ensure that we're successful.

One thing in that regard that really helps us out and that maybe doesn't get terribly a lot of attention, but I think we may have mentioned this on a prior call, is that if you look across our organization, the area of the organization with the highest retention rate across the entire Company is sales. Our average retention rate within our sales organization is longer than the lifetime of some current public companies. It's not that long. It's only five or six years, but it's long. And look, that's not for lack of being prepared when there's nonperformance to take action, because we do. Matt certainly does. But it mostly reflects the fact that people have done well, and then they've taken lessons learned and then they do better, and then they take those lessons and then they do better the next year.

And it's an incredible luxury that we have that is -- that we're dealing with a team -- and we just met as a sales team a week or two ago -- and we're dealing with a team that knows each other, that knows what we do. And if you compare that to some of the other companies, whether in the SaaS space or benefits type space, or even some of the folks that have tried to build up a sales force in this area within financial services, it takes some time to get to really know how to do this. So we view those as valuable assets. And when they win, we win and vice versa. And so that's, again, just been a real luxury that we've all had that helps us improve every year.

Great. And two more questions, if I might. One would be expectations around the effective yield. And then secondly, any commentary you can give with regards to client and account retention.

Yes, on the yields, a year ago our average yield was 152. This year, it was 157. As Jon mentioned, we placed nearly $1 billion of cash AUM in our fourth quarter. And we've said in the past that we would expect that those yields going forward would be consistent in that range for the last two years.

With respect to retention, the way we that look at retention is from year to year how many accounts that were opened last January are still open this January. And for the last three years, that number has been 97.4%, 98.3%, 97.7%. So we're right in that 97%, 98% range each year on retention.

Fantastic. Thank you.

And with no further questions in the queue, that does conclude today's conference. We thank you for your participation.

Thanks, everybody.

Thank you.

Thank you.