Healthequity Inc (HQY) 2017 Q2 法說會逐字稿

Welcome to HealthEquity's Second Quarter of Fiscal 2018 Earnings Conference Call.

Please note that this event is being recorded.

And I would now like to turn the conference over to Richard Putnam, Investor Relations.

Go ahead, Mr. Putnam.

Thank you, Sandra, appreciate it.

Thank you, everyone, for joining us this afternoon.

Welcome to HealthEquity's Fiscal 2018 Second Quarter Earnings Conference Call.

With me today, I have Jon Kessler, who's our President and CEO; and Dr. Steve Neeleman, who is Founder and Vice Chairman; and also Darcy Mott, who's our Executive Vice President and Chief Financial Officer of HealthEquity.

We will reference today's earnings release and the accompanying financial information, which was issued in a press release about an hour ago.

You can find a copy of that posted on our Investor Relations website at ir.healthequity.com.

In the earnings release and during our conference call today, we will reference forward-looking statements, which include predictions, expectations, estimates or other information that might be considered forward-looking.

Our forward-looking statements are subject to risks and uncertainties that may cause our actual results to differ materially from statements made today.

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

In connection with those forward-looking statements, we will present some important factors relating to our business, which could affect these forward-looking statements.

We encourage you to review the discussion of these factors and other risks that may affect our future results or the market price of our stock, which you can find detailed on our annual report on Form 10-K filed with the SEC on March 30, 2017, and in subsequent periodic and other current reports filed with the SEC.

We are not obligating ourselves to revise or update these forward-looking statements in light of new information or future events.

Now with all that out of the way, I'll -- let's get to the real reason for this conference call, and I'll turn the mic over to Jon Kessler.

Thank you, Richard, and thanks, everyone, for joining us.

We began this fiscal year with a commitment to you to continue to outpace market growth and, at the same time, to have the opportunity to increase margins.

Steve, Darcy and I are pleased to deliver second quarter results very much in keeping with that important commitment.

So I'll start off the call with a few thoughts on Q2, including some highlights beyond the numbers.

Steve is going to discuss industry developments, including our sense of the legislative and regulatory goings-on.

And finally, Darcy will review in greater detail the quarter's financial results and management's improved outlook for the full fiscal year.

Here's me.

During Q2, the 4 key metrics that drive our business grew between 26% and 30%, and all hit new records.

Revenue grew 29% year-over-year to $56.9 million.

Adjusted EBITDA grew an even larger 30% year-over-year to $23.9 million.

HSA members at quarter's end were 2.9 million, up 28% from -- sorry, up 26% from a year ago.

And custodial assets at quarter's end were $5.4 billion, up an even larger 28% from a year ago.

These year-over-year comparisons, by the way, do not benefit from competitive portfolio acquisition.

HSA members from the previously announced partnership with First Interstate Bank and Bank of the Cascades will come aboard in Q3.

And prior to that, our most recent acquired portfolio from M&T was onboarded 5 quarters ago.

Turning to sales.

HealthEquity opened 119,000 new HSAs during the quarter, and that's 40% more than during the second quarter of fiscal 2017.

It's also more than any second quarter or any first quarter or any third quarter in the company's 15-year history.

With this great start to the first half of fiscal 2018, we are prepared to move forward in the second half with investments in the sales growth strategies that Bill Otten outlined in our first quarter earnings call.

These will allow us to further expand our leadership position in the HSA market.

Our HSA members added $147 million in custodial assets during Q2.

That's 20% more than had been added during the second quarter of fiscal 2017.

And importantly, members continued to respond in Q2 to HealthEquity's focus on saving.

The number of members investing grew 65% year-over-year, and invested custodial assets grew 61% year-over-year.

As a reminder, investments are integrated into HealthEquity's proprietary platform.

Proprietary platform ownership, which is something our largest competitors do not have, means HealthEquity can offer more to keep fees low and can retain value for our shareholders.

How do the results I described compare to the market as a whole?

Devenir published its midyear market report a number of weeks ago, estimating that the market grew HSAs by 16% and HSA assets by 23% year-over-year.

The comparable health equity figures are 10 percentage points ahead in HSAs and 5 percentage points ahead in custodial assets, with revenue and adjusted EBITDA growing even faster.

Devenir estimated that invested HSA assets market-wide grew 45%.

The comparable HealthEquity figure to 16 percentage points higher.

So the results we report today put HealthEquity handily ahead of market growth.

And as I said at the start, we're committed to stay ahead of the market as HSAs go mainstream.

Beyond the numbers, allow me to highlight a few other key Q2 developments and update you on recently reported transactions, 4 items here.

First, during Q2, Morningstar named HealthEquity the best HSA for investors.

That is a remarkable achievement for the team at HealthEquity Advisors, which is our only one of its kind investment advisory subsidiary.

The HealthEquity Advisors team has embraced the concept of best interest of the customer from day 1. And that's why HealthEquity members enjoy the industry's lowest fund expense ratios and, at the same time, its highest quality investment options.

This includes the highest percentage of Morningstar medalists and the highest percentage of Morningstar gold medalists.

We do not bury those gems underneath a pile of high-cost proprietary funds because we do not have proprietary funds.

And we offer low-cost online investment advice, which is still an industry-first, to every HealthEquity member.

Now there's a long, long, long -- a lot of long from this page, road ahead, but the shift towards using HSAs as a first dollar vehicle for tax-efficient savings is underway.

And HealthEquity, true to our name and true to our model of building health savings, is leading the way.

Second.

During Q2, we completed the integration of BenefitGuard, now part of HealthEquity Retirement Services.

Thanks to the work of the HealthEquity retirement team and our Advisor and service partners, more than 99% -- and in fact, it rounds to 100%, I feel a little Trump-y there, of the 401(k) Assets managed by BenefitGuard transitioned to HealthEquity.

Recall that our health well strategy has 2 components: First, we're providing small and midsized employers a fully integrated 401(k) HSA product as well as a great 401(k) for those without HSAs.

Like our HSA, we're going to deliver low cost, we're going to deliver less work for employers, and we're going to deliver an engaging Purple member experience that helps people build savings.

This is what we acquired BenefitGuard to do.

Second, for our largest employer partners, we're making technology -- we call it [Wellview]available that enables members to link HealthEquity to their existing retirement plan provider.

In an early trial, 38% of HealthEquity members exposed to Wellview links actually used them, and that's a really promising start.

Third development from the quarter.

During Q2, HealthEquity began showing current and prospective partners' results from the largest demonstration yet of the power of our consumer health ecosystem.

Over 2 months, HealthEquity exposed a diverse population covering nearly 5% of our HSA membership to data-driven, multichannel education on the topic of online medicine.

And that included financial incentives and linkage to third-party services that provide 24/7 live doctor visits via a mobile phone.

Nearly 1/4 of HealthEquity members who received education dug deeper, actively exploring online medicine offerings, the financial incentive involved and, in some cases, already visiting with doctors online.

We believe that as services, such as online medicine, demonstrate their value to consumers, HealthEquity's platform is uniquely positioned to introduce these consumers to the -- these services to the emerging health consumer.

Fourth and finally, during Q2, HealthEquity announced a portfolio acquisition and partnership with First Interstate Bank and Bank of the Cascades, which, as I referenced earlier, is our first such transaction in more than a year.

Onboarding of the Bank of the Cascades portion of the portfolio was completed rapidly in August, and we expect to complete the First Interstate portfolio portion this month.

I think this speaks well to the benefits of our strategy with regard to portfolio acquisitions.

Health care discussions in Washington and how employers and consumers perceive them have been a hot topic over the last few months.

Steve is in a unique position from which to provide perspective, being active both inside the Beltway and with HealthEquity's partners and prospects nationwide.

With Congress just returning from its recess, I think the timing is ideal to provide you with our view of what happened over the summer and what we can expect during the rest of the year on the legislative and regulatory fronts, and Steve is going to do that.

Steve?

Thank you, Jon.

I want to start by reminding everyone what we said 6 months ago as the new administration was moving into the White House, and there was a lot of hype about how they were going to help the HSA market and in fact, as what we've been saying since before our IPO, that growth in HSAs has been and will continue to be more about economics than it is about legislation.

Our network partners have grown their HSA footprint not because of past, pending or potential government intervention.

They have grown because HSAs make economic sense for their employees and for their businesses.

While we expect the new administration and Congress to provide some additional tailwinds, the stronger current has always been and continues to be the fact that HSAs work.

Over the summer, while Congress failed to reach consensus on repeal and replace of Obamacare, it did agree on a few things, HSAs chief among them.

Pro HSA amendments were among the few to pass both the House and Senate during the Obamacare debate.

And even Democrats saw "room for compromise" around HSAs.

The general health affairs cover the work of the Problem Solvers Caucus, a group of 23 Republicans and 22 Democrats advocating for the practical goals of stabilizing the insurance markets, adjusting employer mandate thresholds to avoid unintended consequences and expanding the use of HSAs.

Last week, the Senate Parliamentarian set a deadline of September 30 for using budget reconciliation.

That's the 51-vote process to amend the ACA.

And evidence is mounting that action is needed to stabilize public exchanges serving people who cannot obtain health insurance from their employer.

Facing urgency and having heard from their constituents during this recess, legislators will perhaps return to realistic solutions.

If so, we are confident HSAs will be chief among them.

As tax law changes are proposed, HSA expansion provisions may also find a home in tax reform legislation, showing there is more than one way to bite this apple.

Meanwhile, we believe that serious work is ongoing in the executive branch, specifically in HHS and the Treasury Department, on HSA reforms that would not require Congress to change the law.

Regulatory development may be harder to follow than congressional votes or debates on C-SPAN, but it could have profound impacts, including the following: first, expanding the scope of health insurance that is considered HSA-qualified, which the University of Michigan Center for Value-Based Insurance Design estimates could increase the number of Americans in HSA-qualified plans by 40 million; second, altering prior regulatory opinions that prevented otherwise HSA-eligible working Americans, such as those who have earned secondary health coverage through Medicare, veterans or military benefits from opening HSAs.

By 2022, it is estimated that over 13 million Medicare recipients will still be working.

This change would allow these consumers to continue to save money in HSAs while they are working.

Third, easing the transition from FSAs and HRAs to HSAs by revising past opinions to allow HSA-eligible individuals to distribute unspent money in these accounts to their new HSAs.

This would allow consumers to build their health care savings and not be forced to spend their FSA and HRA dollars due to the fear of the "use it or lose it" and nonportable feature of these accounts.

And finally, numerous actions may be under consideration to help Americans fully utilize HSAs, such as clearly labeling insurance plans of HSA qualified on federal exchanges and publications and promoting clear and fair medical billing practices for consumer [days].

But again, we need to stress that the fundamental driver of the HSA market and of HealthEquity is that HSAs work for consumers, for employers and for health plans, and HSAs help to create a more consumer-responsive and cost-efficient health system.

This explains what we have observed away from Washington: employers are working hard at the longer-term objective of transitioning their health benefits to HSA-style plans.

In August, based on its 2017 large employer health plan design survey, the National Business Group on Health concluded that HSA-styled plan options will be nearly universal among large employers by 2020, just as we predicted at the time of our IPO.

The sales figures Jon discussed previously provide further evidence that employers and consumers are focused on what works.

We are hopeful that eventually, Washington will do the same.

I will now turn the mic over to Darcy to review the financials.

Thanks, Steve.

I will discuss our results on both a GAAP and a non-GAAP basis.

A reconciliation of the non-GAAP results that we discuss here and in the press release to their nearest GAAP measurement is provided in the press release that was published earlier today.

I will begin by reviewing our second quarter financial results, and then I'll update you on our business outlook for the full fiscal year 2018.

Revenue for the second quarter grew 29% year-over-year to $56.9 million.

Breaking down the revenue into our 3 components, we continued to see growth in each of service, custodial and interchange revenue during the quarter, with custodial revenue continuing to gain prominence, as anticipated.

Service revenue grew 21% year-over-year to $22.8 million in the second quarter.

Service revenue as a percent of total revenue declined to 40% in the quarter, down from 43% of total revenue that it represented in the second quarter last year as the custodial revenue stream became more predominant.

Service revenue growth was attributable to a 26% year-over-year increase in average HSAs during the quarter, partially offset by a 4% decrease in service revenue per average HSA.

On a year-to-date basis, the decrease in service revenue per average HSA was 5% compared to the prior year, which is at the low end of the estimated 5% to 10% decrease we expected and discussed in our previous guidance.

Custodial revenue was $21.3 million in the second quarter, representing an increase of 44% year-over-year.

Custodial revenue growth was fueled by 23% growth in average custodial cash for the quarter and the higher annualized interest rate yield on custodial cash of 1.83% during the quarter compared to 1.58% in the second quarter last year.

This also reflects an uptick from the 1.72% yield that we reported in the first quarter this year.

It is somewhat unusual to see that large of an increase in our yield from the first quarter to the second quarter, but this uptick was partially due to one of our bank partners needing to exit early out of a depository contract.

We accommodated their request and had successfully deployed these funds at market rates with other banks, and we now expect that we will be in the 1.8% yield range for our custodial cash on a full year basis.

On a year-to-date basis, our yield on custodial cash was 1.78% compared to 1.56% in the prior year.

61% year-over-year growth in invested custodial assets also contributed to custodial revenue growth.

Invested assets accounted for 16% of custodial assets at the end of the quarter, the most in the company's history.

Interchange revenue grew 21% in the second quarter to $12.8 million, compared to $10.6 million in the second quarter last year.

Interchange revenue benefited from the 26% year-over-year increase in average HSAs in the quarter compared to the same quarter last year, offset by lower spend per average HSA compared to the prior year.

Gross profit grew 25% in the second quarter to $35.8 million compared to $28.6 million in the prior year for a gross margin of 63%.

Cost of revenue included additional fraud prevention measures, as we indicated in our last earnings call.

Operating expenses were $19.3 million or 34% of revenue, compared to $15.8 million or 36% of revenue in the second quarter last year.

Income from operations was $16.5 million in the second quarter, an increase of 29% year-over-year and generated an operating margin of 29% during the quarter.

We generated GAAP net income of $16.9 million or $0.27 per diluted share in the second quarter compared to $8.2 million or $0.14 per diluted share last year.

Of the $8.7 million increase in GAAP net income, $6.5 million is attributable to the adoption of Accounting Standard Update 2016-09 at the beginning of this fiscal year.

We generated non-GAAP net income of $12.8 million for the second quarter of fiscal 2018.

Our non-GAAP net income per diluted share for the second quarter was $0.21 per diluted share.

Our adjusted EBITDA for the quarter increased 30% to $23.9 million compared to $18.4 million in the prior year.

Adjusted EBITDA margin in the quarter was 42%, consistent with last year's record second quarter.

For the first 6 months of fiscal 2018, revenue was up 27% compared to the first half of last year.

GAAP net income was $31 million compared to $16.3 million last year.

Non-GAAP net income was $24.7 million.

Non-GAAP net income per diluted share was $0.40, and adjusted EBITDA was $46.4 million, up 27% from the prior year.

Turning to the balance sheet.

As of July 31, 2017, we had $210 million of cash, cash equivalents and marketable securities with no outstanding debt.

Before I turn to our business outlook for the remainder of fiscal year 2018, I want to remind you of our discussion in the first quarter concerning the effect of Accounting Standard Update 2016-09 has had on option exercises and on our income tax provision.

Under the new accounting standard, we have an income tax benefit that reduced our income tax provision, resulting in the higher GAAP net income and GAAP net income per diluted share in our second quarter and first half of fiscal 2018 than what they would have been under the old standard.

We have reported a non-GAAP net income and non-GAAP net income per diluted share to provide you a clearer comparison to the prior year without the impact on taxes from the accounting -- new accounting standards.

Because of the inherent difficulty in forecasting the timing of stock option exercises, the potential variability in our stock compensation from multiyear performance criteria and the variability in the size and timing of new equity grants, our fiscal year 2018 business outlook includes guidance for revenue, GAAP net income, adjusted EBITDA, non-GAAP net income and non-GAAP net income per diluted share.

We have provided a definition of such non-GAAP measures and the reconciliation of each to the most comparable GAAP measures in the earnings release.

Now turning to our full year fiscal 2018.

We are increasing our business outlook for the year ended January 31, 2018, as follows: We are increasing our revenue outlook from a range between $222 million and $227 million to a range between $223 million and $228 million.

Our net income outlook is increasing from a range between $33 million and $37 million to a range between $41 million and $45 million.

However, we do -- we are not making any forecast with respect to additional stock option exercises during the year, which would have the effect of reducing income tax expense and increasing GAAP net income.

Our adjusted EBITDA outlook is increasing from a range between $78 million and $83 million to a range between $79 million and $84 million.

We also expect our non-GAAP net income to be in a range between $39 million and $43 million, up from the prior range between $38 million and $42 million.

Our non-GAAP net income is calculated by adding back to net income all noncash stock-based compensation, net of an estimated statutory tax rate of 38% and the impact of the excess tax benefits due to the adoption of Accounting Standards Update 2016-09.

Our non-GAAP net income outlook results in non-GAAP net income per diluted share range between $0.64 and $0.68 per diluted share based on an estimated 62 million diluted weighted average shares outstanding, up from our prior range between $0.62 and $0.67 per diluted share.

Before I turn the call back to Jon, I would like to mention 2 additional items reflected in our business outlook.

As in past years, our service delivery costs will increase in the third and fourth quarter as we ramp up for the new accounts coming onboard in January.

Second, in addition to some of the comments that Jon mentioned earlier with respect to sales initiatives in the second half of the year, our business outlook also reflects our normal seasonality in sales and marketing expenses for sales commissions as accounts come onboard in the second half of the year.

With that, I'll turn the call back over to Jon for some closing remarks.

Thank you both, nice job.

To the extent that you assign credit for the results that we delivered today, that credit appropriately belongs to our fellow HealthEquity team members in Draper and Price, Utah; in Kansas City and around the nation who are delivering remarkable service every hour of every day.

So I'd like to say thank you -- I'd like to close by saying thank you to them, and welcome aboard to our new members of Team Purple that are joining us as we ramp up for what, as Darcy said, we hope to be our busiest open enrollment season yet.

With that, let's hand it back to the operator and take some questions.

(Operator Instructions) Our first question comes from the line of Peter Costa with Wells Fargo Securities.

A question regarding the bank that turned back the assets.

Were they concerned at all with these reviews with the broker deposits or, in some way, expensive capital?

What exactly caused the bank to want to give that capital back to you, guys?

I think that we want to leave that to them except to say that the factors were unrelated to HealthEquity.

And unrelated to the cost of your funds?

I can't say that, but to our understanding, not related to any broker deposits or similar concerns along those lines.

Okay.

And you haven't had any reaction from other banks wanting to do the same thing?

No.

And as Darcy mentioned, we were obviously able to place those funds successfully and as the number reflects at current rate.

So we feel pretty good about that.

No -- and I would just add one comment to that, Pete.

It's that over the years, as our deposit base has grown and our number of depositories has expanded and our ability to ladder these out in multiple contracts over multiple durations, it became much easier for us to even just to place these funds in competitive rates for competitive durations.

That's great.

And then looking at the selling cycle for next year, this year, there was a little bit of a slowdown in the market for HSAs in a number of new accounts based on the Devenir data and your own new account growth in terms of percentage growth.

Do you think that had anything to do with the lower increase in health care cost this year perhaps because of the health insurance tax or fee being on holiday this year?

So you sort of had a 3% savings that you would have otherwise had?

So if that came back next year, would that actually accelerate health care cost and perhaps cause the market for HSAs to accelerate again as more employers would have to adjust?

Yes, I can barely drive a car, Pete.

So I'm not sure I should -- I can predict with that level of precision.

Some people would say I can't drive a car.

But honestly, I guess, I think a better way to think about this at least in terms of our numbers -- and obviously, this has been a topic of some discussion the last couple of months is to take a kind of a step back and say you've got roughly 20% of the commercial market in HSA products.

We've got $45 billion in assets under management market-wide, of which our share is growing every year.

And as we said, at maturity, we see this as $1 billion -- $1 trillion asset market.

And obviously, our mission is -- not obviously, but our mission is that one of the things we can do to really improve health care in the United States is to get to a place where every working family has an HSA.

So we perceive that there is a long, long way to go in terms of the overall growth of the market.

And I think as we said before, as with many other markets like this, it's more likely to be steady than anything else.

And along the way -- and again, you look and look at the history of 401(k)s or whatnot.

There'll be various head fakes and people will -- positive or negative, and people will attempt to assign reasons to the head fake after the head fake happens.

But I suspect that it's a lot of sort of more or less random noise around a core trend, and then the core trend is the one that Steve talked about.

These products work.

And then moreover, people are increasingly discovering their value not just in terms of current savings but long-term savings.

And that's really the overall trend.

So that's kind of the way I would look at it rather than to try and kind of time it one way or the other.

I know that's not entirely helpful in terms of what -- some of our listeners might want to hear, but it's -- that's the way we're looking at it as a company.

I appreciate that.

And then my last question is just how do we monitor the performance in the growth in the 401(k) business?

We don't see those assets being reported anywhere here.

Is that correct?

Or how do we -- how are we going to watch that as it grows for you, guys?

It's a good question and it's something that we'll take a look at as the business begins to mature.

I mean, I'm not sure Apple's reporting the Watches yet so -- sorry, that was intended as a joke if I won't come off that way.

I think Darcy may even have one of those things, but it's something we'll take a look at.

As it becomes material, we'll try and find ways to make it more visible to you.

Okay.

But just to be clear, it's not affecting any of the numbers that we're seeing in terms of assets today?

No, it is not.

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

A number of questions, I'll try to limit to just a couple.

First, just building on your commentary around cash AUM growth and invested -- investment AUM growth, are you seeing any downward pressure on the growth rate of custodial revenue as a result of the fact that invested assets are growing faster than cash?

I think -- Greg, thanks for the question.

We have 44% growth in custodial revenue.

And we have always commented, when asked this question, that we believe in building health savings.

And we think that having this investment platform, this proprietary ability for people to invest their HSA dollars in low-cost funds is a winner for us.

We know that people will keep some portion of their HSA assets in cash for emergency funds or whatever.

And so we look at the shift from cash to investment as being an additive exercise for most of our members, and so we welcome it.

We think it's a smart thing for them to do.

But when it's good for them, it's good for us.

And so we don't think that that's going to impede the growth of the custodial revenue line.

We think that the custodial revenue line will continue to grow as a percentage of our total revenue.

Great.

I feel like it's a mandatory question I've got to cover.

Another big picture question.

Can you talk a little bit about your success in the large employer market versus the middle or small employer market and perhaps how you might be changing your distribution or selling strategies to impact the results?

Yes, that is also a good question, Greg.

Thank you.

We hope you're getting the hurricane shutters battened up there on the place down in St.

Pete.

You may need those but -- not because I'm blowing hot air but (inaudible).

I'm here all week.

But look, the real answer is, as you know, historically, HealthEquity's strategy for selling into employers has been focused on the largest employers.

And Bill talked about this last quarter, I believe, and we talked about it a little bit in the prior quarter.

As that -- what started to happen is that some of the same dynamics that we saw a few years ago in the large group market are -- you're starting to see now in more of the middle-sized and smaller group markets.

And so from our perspective, it starts to make sense to attack those in a similar way.

And so as Bill talked about last quarter, we are ramping up to some degree how we approach those markets.

And that is a little bit of the commentary I referenced here in terms of implementing some of what they're talking about.

And there are some differences in approach.

I think the most important difference in truth is that in order to approach these markets in a scalable away, things that you can kind of get away with a little bit in a large group world don't work.

So you have to have brand.

Brand identity matters.

Lead generation matters.

As they used to say when I was much younger and worked at Andersen, there was only 500 Fortune 500 but there were a lot more companies with only 1,000 members or 500 team members.

So you have to be a little more thoughtful about how you approach them.

And sales management frankly matters.

So both marketing and sales matter, and this issue is -- was very much top of mind as we recruited Bill in his position and Gary Robinson on the marketing side and in the investments that we're making in those areas, was the feeling that the time is emerging where these markets are actually going to see growth in HSA membership.

And so they're great markets for us to focus on, both directly as well as with our partners.

So I guess those are the differences.

At the same time, in the large group market, you see much more maturity, and that can help us, too.

So we think we'll have a really nice year in terms of winning some accounts from others who frankly haven't made the kinds of investments to keep up in terms of market leadership.

And hopefully, we'll see that as the year goes on, but I guess that's sort of the sum of my answer.

And just to confirm, you really don't like to talk about enrollment projections, your enrollment projections intra-year.

Is that correct?

Well, I mean, I like to do a lot of things, but we don't provide guidance on year-end enrollment.

It's the most difficult variable we have to project because, as Darcy will attest it, it's something where we get a lot of information crammed in at the end of our fiscal fourth quarter and relatively little information prior to that.

That having been said, look, the fact that -- if you look at it over the year-to-date period, we've opened almost 200,000 new accounts.

That's -- and actually, even if you compare that number to the total annual growth of a number of our major competitors last year, we can feel pretty good about that.

We're off to a good start.

Right.

The final question I have is just around your largest shareholder.

We observed that they did sell some stock in July.

And I'm just curious if they've had any discussions with you about their longer-term intent.

And if there's been none, then that's fine.

Just curious if you've had any feedback from them.

No.

I mean, the short answer is no.

I think that the unit where these sales occurred is not -- these aren't folks we talk to on a regular basis.

So -- and I know our -- and I don't believe that the member of our board, who's also an employee there, really has much to do with it.

So I don't -- we haven't really talked about it in some time.

And our next question comes from the line of Stephanie Davis with JPMorgan.

So now that it's been a quarter, could you talk to any change in competitive dynamics that you've been seeing since Anthem's announced partnership with Allegis?

As a follow-up to that, how should we think about the stickiness of your existing Anthem-affiliated members?

Yes, I'm not sure that I have much to add to what we've said previously because I don't know that I've seen anything different.

That is to say what we expected is that Anthem would have this offering that economically, it would be very similar to what we offer and that Anthem reps would offer it side by side to groups as they come up for renewal.

And that is renewal on the Anthem side of things and -- that it might have more stickiness for those groups that are kind of all-in Anthem as opposed to those groups where it's a slice or more traction, I should say.

And lastly, that if groups are happy with what we're doing, that the incentive to switch isn't terribly compelling.

That doesn't mean they won't sell accounts.

I assume they will, but I think that's basically what we've seen.

So the bigger impact really is I think on sort of particularly in the national account space that we work with Anthem on, it's really -- there are cases where I think you might see and you do see that our people have to do their job, too.

That is to say we have to be there presenting the value of HealthEquity, and that's always been true to some extent but it's -- in these cases, it's more true now.

So that's what we do.

I don't really see anything remarkable in terms of us seeing accounts.

And again, this is -- can vary as far as expectations, seeing that accounts aren't sticky or what have you.

And obviously, the sales numbers we've reported to date, though they tend to be from the smaller employers and the like because it's early in the year, certainly show that we're doing just fine and attracting growth.

So I guess that's kind of my -- if I had to again summarize all that, I would say it's really as we expected.

Do I think that there is -- effectively sort of puts another competitor on the market?

Sure.

Is Anthem a portion of our growth?

Of course.

Is it a huge portion of our growth?

No.

And do we continue to work with Anthem where it makes sense for both companies?

The answer is yes.

That makes sense.

Darcy, anything to add, or Steve?

Look, I -- we've -- for the last -- Stephanie, as you know, for the last 15 years, we battle every day and we have partnerships that are great partnerships and we consider Anthem to be continuing to be a great partner, but that has never taken the responsibility off of our salespeople's plates to get in front of clients, get in front of consultants and say, look, we've got a great partnership with Anthem but that's not good enough for you to buy HealthEquity.

You need to buy HealthEquity for other reasons.

And we've been doing that before, during and today with our relationship with Anthem.

Yes.

And I would just add to that, Stephanie, that I mean, we look at our -- how our health plans are doing year-over-year and whatever, and we're still getting accounts from Anthem every month.

And we would expect that, that will continue just because of the market that we address with them and the contracts and the relationships that we already have in place.

And our next question comes from the line of Sandy Draper with SunTrust.

Most of my questions have been asked, and you guys did a great job answering.

Maybe just one, Darcy.

I may have missed this in your prepared remarks.

I remember last quarter, you talked about sort of flat sequential gross margins in the second and third quarter because of some higher onboarding cost.

And I think there is also some regulatory cost.

Obviously, you've got expanded margins by a couple hundred basis points.

Just thoughts on what did or didn't happen in the quarter that drove it.

And would we expect the margins to trickle back down in the third quarter?

I mean, clearly, the fourth quarter, when you have the big onboarding, margins had a bigger drop.

But just trying to think about the 2Q to 3Q sequential trend in gross margins.

Yes.

Thanks, Sandy.

So we did have -- as we talked about both in our year-end call and about the service delivery cost related to fraud prevention, and we have incurred those.

Some of that was incremental expense, and some of it was hiring some more people to be on the phones.

And so there has been a little bit of a smoothing effect, as what we talked about, on the margins for the first half of the year.

However, part of the margin benefit that we've got in the first quarter or in the second quarter to the 63% was the yield helped us a fair amount on that front.

So the guidance that we have given is consistent with what we've had in the past.

It's that we are going to have increased service delivery cost in our third and even more so in our fourth quarter as we ramp up.

We've already begun hiring people and onboarding new member services people to get them onboard.

Open enrollment season is upon us, and we send people out all over the country to participate in that.

And so from a margin perspective, it's probably going to be a little bit less dramatic from quarter to quarter, but the effect will be that we will still have increased service delivery cost in the third quarter and then even more so in the fourth quarter.

And our next question comes from the line of Mark Marcon with R.W. Baird.

Was wondering if you could go back to some of the original commentary that you started the call with in terms of the strongest second quarter in terms of new accounts being present.

Was any of that due to First Interstate or Cascade?

Or what was the contribution from those?

Or did that -- is that falling into the third quarter?

No, not -- thank you for the question, Mark.

No, not at all.

First Interstate and Bank of the Cascades will show up in our end of Q3 results.

There is no impact from those in Q2.

And so really, this represents, from my perspective, a little bit of the beginning -- hopefully the beginning of the effect from some of the strategies that Bill outlined as well as just continued execution on the part of the sales team.

We did see a client or 2 move toward -- closer to full replace of some of our enrollments that occur in July, for example, that there are certain -- July is a month where you have some employers that end their plan year, you've certainly got the benefit of that.

And that's been true in other years as well.

So I would just say more that we saw general strength in the quarter in terms of sales and really the benefit of First Interstate is yet to come.

And could you remind us what First Interstate and Cascade on a combined basis will end up adding in terms of accounts?

Darcy?

Yes, I don't think that we've actually published that number.

We're waiting for the actual custodial transfer to take place in the quarter, and then we'll announce what those net results are.

Okay.

But I mean, if we basically use some of the historic metrics in terms of what you paid, we can kind of get there, right?

Yes, it would be consistent.

I think that we said something in the 50 million...

10,000 to 15,000 accounts and 50 million to 60 million.

Yes.

We just haven't given the final number yet.

We have a range.

So there -- these aren't huge, but certainly, our hope is that -- I think we commented in the last quarter that there was a little bit of a falling in the portfolio acquisition market, and perhaps this transaction was sort of getting underway at that point and that influenced that comment.

I think that's true.

People are obviously returning to a level of both feet on the ground post-election and all of that, and so I think people are starting to take a look at the fundamentals again, and maybe we'll see more of these kinds of transaction.

So there's really strong second account -- second quarter account signings.

I mean, was it primarily concentrated in existing clients that -- where they just had more people sign up or new clients that joined?

At the level of -- at the partner level, meaning, at the -- we call the network partner level, it's mostly existing because that's sort of the way that works if you think about it.

But for example, let's say it's -- the health plan is SelectHealth as an example, a great partner of ours.

I'm going to be sorry I mentioned that somehow, but they are a great partner.

There might be individual employers that are affiliated with them that come on in June or July or August or what have you.

But at the partner level, it's not that -- for example, there isn't one new large employer or anything like that.

Okay, great.

And then with regards to the success that you're seeing in terms of getting the behavioral change towards -- a shift towards investment account, what's the right custodial fee percentage to think of out of those investment accounts?

Well, we -- it's a good question.

We think the right way.

You've got to actually sort of maybe look at it in terms of absolute numbers.

If you look at the average 401(k), for example, the average balance of a 401(k) is in the kind of $80,000 range.

And all -- on an all-in basis, average fees for those accounts can range from, all-in, 50, 60, 70 basis points for the largest plans to 150 or 200 or 250 basis points for the smaller plans.

What we're offering is for average balances on the investment side that are around $10,000, we're offering fees all-in at roughly 50 basis points, depending on the funds you select and all that, that are competitive with what the largest 401(k) providers would offer to their largest plans.

And we think that's pretty good for $10,000 balances and accounts that have a hell of a lot more transactional activity than your 401(k) does.

So that's kind of the way we look at it.

We've been, I think, pretty successful at articulating that.

Frankly, our biggest challenge has been -- over the course of the last year or so, has been that we still have many of our competitors who -- and these are the same folks who have -- even as recently as the last month or so, have come out publicly against the concept of a non-biased advice and fee transparency and the like that are at the heart of the fiduciary rule.

And so the game they're playing is to kind of hide the ball on some of those fees.

And so there's a market education challenge there, but it's really one that we relished because at the end of that, we know we're wearing the white hat on that one and we know that's where the market is going, and everyone knows it's where the market is going.

So let's build the business on that foundation now.

And so right now, we're generating again high 30s to 40 basis points of custodial income to HealthEquity across the entire book of invested assets.

And again, if you look at that on a total dollars basis and compare it to what even the most competitive products are out there in the 401(k) landscape, which are obviously balances that are 8, 10x as large as ours, you can feel pretty good about it.

Great.

And then with regards to just the change in terms of the guidance in terms of picking up the profit expectations materially more than the revenue, that's because of the shift, with the custodial basically encompassing a greater percentage.

Is that correct?

Well, the revenue range guidance and EBITDA range guidance, the increase was about the same.

So as we've done in prior quarters, we're basically taking the improvement over what our expectations were and having -- and increasing the guidance accordingly.

I think if anything, as we suggested and I suggested and Darcy elaborated on, we're -- this is from our perspective of period where we feel really comfortable taking a little bit of that good portion and giving Bill, Gary and the company the tools that they need to -- not just for this year but really to begin prepping for next year.

I mean, it's hard to -- funny to think about it that way, but we'll begin hiring reps in the next year within the next month or so.

And so we're -- that's kind of the way we look at it, I think.

And our next question comes from the line of Donald Hooker with KeyBanc.

I am very interested in your comments.

You were talking about online medicine.

I assume you're referring to telemedicine there.

And I wanted to -- I'm very interested in that, sort of building that -- sort of, for lack of a better word, an ecosystem there with third-party vendors.

What -- can you talk about that a little bit more?

Like what is this education that you're providing to this 5% of your membership?

And are they -- are you seeing -- can you -- is it possible to quantify the usage of telemedicine through your platform?

Yes.

Thank you for the question, Don.

I think this is really important, and it does kind of get lost a little bit in all of the hard numbers.

But our view -- I mean, something that people sort of forget is (inaudible) position, and I don't forget it because I think -- I'm worried that I'm going to wake up one day, it's going to be cutting on me.

But -- it's like a Jimmy Buffett song, just -- but the health side of it is, is pretty important, and one of the things that we've tried to do that -- frankly, it was a decision made long before I showed up.

It's really to construct the platform in a way that we weren't just managing the dollars and cents, but we're leveraging that financial interaction to help people make some smart health decisions and -- because that was what Steve observed people doing, what caused him to start the company in the first place.

And so this is kind of an example of that.

It turns out that doing that is not simple.

It -- because one, there's a lot of services out there.

Two, people tend to only hear about them during open enrollment or whatnot when the spouse that actually makes the decision, may not be paying attention, or no one may be paying attention, and there's a lot of information out there.

So what we've tried to do is to use data and -- as well as other forms of insight to try and begin to construct a scalable method for delivering information to consumers about services that are available to them that can help them save money and get better health that their employers are paying for, their health plans are paying for, that people want them to use and that they are willing to use but they just don't know about them.

And so this was kind of our largest test of that.

We took a group of members -- I want to say 150,000 members, and we exposed different messages.

In some cases, we used the website.

In some cases, we used video, changing the messages based on their demographics, trying -- and it was very -- in this case, was very focused on -- as you say, on particular telemedicine services that employers or health plans were already paying for.

They're already offering them.

And it's interesting; for some people, a message very focused on "This is cheaper than going to the doctor," right.

It's really effective or there's a -- "You're going to get $10 off because your employer is offering that incentive." That can be very effective.

For other people, it's about the convenience of it, of you don't have to spend all day at the doctor's office just to get an antibiotic script.

And for other people, it's about a different kind of access.

If you think about mental health, for example, the telemedicine relationship is, in some ways, potentially more intimate than other ways that you'd access a mental health professional.

And so a lot of what we're trying to do here is figure out what works and what works on a scalable basis.

And as we do that and as the health ecosystem grows and, in particular, as there are more services out there that consumers really want and -- that's still a tough one.

A lot of the services, people want consumers to have but consumers aren't necessarily screaming for them.

We think that we're in a great position relative to our competitors to bring added value to everyone involved, to our partners, to the members, to these ecosystem providers themselves.

And so this is kind of us just saying, "Hey, we're still working on that, and we're still spending money on it." And it's something that people continue to see from us, but it's not something we scream about every quarter.

But it is something we continue to work on.

And again, as the ecosystem itself gets more varied, then we're going to have more opportunity to do this.

And Steve, want to add anything to that?

Yes.

Two things.

First, I will not be betting on Kessler anytime soon for the record.

Second thing is that this is in line with our mission.

I mean, when we wrote the business plan that's now over 16 years ago, right, we were talking about how do we help consumers navigate, how do we help them save more, how do we help them spend less, and what's -- there's this kind of beautiful alignment of incentives if you think about sales.

A consumer wants to spend less, like they do in the rest of their lives, they want to spend appropriately, right.

By them spending less we have more to manage, which is still a fantastic one between us but then also, their employer and their health plan also benefits.

And so we call it kind of quadruple alignment, consumer, HealthEquity, employer and then ultimately the health plan if they're at risk.

And look, I think even my colleagues in medicine, many of which are now starting to convert to HSAs kind of at a personal level and big provider systems and things like that, we do a lot of work with, they're starting to realize that these really, really work.

And so it's kind of sweet to have a business that has this virtual mission to help people that in doing so, we get to manage more money and we get to make more money for investors.

You wouldn't get -- I mean, your vision here is to be collecting, generating revenue through this channel, I guess, where if I'm a telehealth provider or whoever.

I would be using accessing HSA members and you would be in the middle collecting a fee.

This is Jon.

We do that in some cases, but I'll say we don't want to put the cart before the horse.

And the horse in this case is the products have to be one that consumers want, and we have to be truly and durably effective at delivering those consumers.

I've seen so many activities -- one might call them business development deals where the party spends so much time dividing up revenue that doesn't exist yet that they don't ever get to the actual stuff that works, and we feel like we're in a great position.

We're doing well as it is from the business that we have.

But absolutely, whether it's directly and the way you described -- and we do have some of that kind of stuff today.

But whether it's directly and the way you've described or indirectly in terms of the result being that we're more valuable to our partners and we're differentiating with our partners and that's the reason for an employer or a health plan to both partner with us and/or spend time promoting us or indirectly because it makes us more relevant to a member, but there's a lot of ways for this one to pay off for us.

And so we're kind of more focused at the moment on, like "Let's get this to really work." How many companies I'm asking this rhetorically, Don, how many companies have you seen that have gotten over their skis on, "We can deliver, engage members," et cetera, et cetera, et cetera, try to build a revenue model around that, and then "Oh, by the way, it turns out that the engagement isn't all that durable." And that's not where we need to be, and it's not where we want to be.

So we'll keep making money the way we make money, and we can be a great partner doing that, but of course, over time, if there's ways to incrementally add value here, that's what we'll do.

I -- well, I guess I'll leave it at that.

And our next question comes from the line of Mohan Naidu with Oppenheimer.

Just a quick couple of questions.

First, on the benefit guide, it's great to hear about the 100% transition.

Can you talk a little bit about what do you see as the cross-selling opportunity either into the benefit guide book are taking your integrated product into your customers given it is the current selling season as we go into 2018?

I think it's tremendous.

I will say, if anything -- and we've had, even this week, a couple of discussions on this internally.

We made a decision that for the current fiscal selling season that we would not kind of go crazy on the cross-selling thing, that what was most important at the outset was to bring these customers, introduce HealthEquity to the existing customers.

We have a lot of learning from those customers, a lot of learning in terms of educating our team about what the retirement market looks like, beginning to learn truthfully from the advisers themselves.

A key point here is that from our perspective, well, I say -- so let me back up.

So that was our goal for this year, and that's why we have generally not -- we've been comfortable really, to Pete's original question, to say, "Look, give us some time to learn a little bit and then we'll -- if we think it's material, we'll break -- we'll talk more about this." And -- but that having been said, here are the opportunities: first, there's the opportunity to -- and these are really why we think that the [Health Wealth] thing is a win-win for us almost any way you put it.

First, right, the retirement market is a $7 trillion asset under management market.

We -- our market today is $45 billion.

$7 trillion is more than $45 billion.

And so the opportunity for us to offer product in that market, which we are now able to do and to offer something that is truly different is -- I think, is material.

And we'll hone it.

We'll do it right.

I'm sure if we were just a 4-person start-up, we might be a little bit more seat of the pants on this, but we're going to do it right.

And we're in a great position to do it in part because we're also kind of thinking about it, I think, right from day 1, sort of consistent with the idea of people wanting low cost.

They want low risk.

The employers don't understand why they're on the hook for investment decisions and all that kind of stuff.

So that's kind of opportunity one.

Second opportunity is -- as you suggest, is the opportunity to grow our HSA base from those customers.

So as I referenced in my comments, there are a lot of people who may start out having a great (k) experience with us, a great retirement experience with us but they are -- get HSA eligible.

It's a great way that now we have -- we'll talk to them about it.

And maybe that person has a flex account with us or no other account with us.

But not the only are we talking about it, but we're talking about it in the context of long-term savings, which brings me to the third point.

And that is that even if neither 1 or 2 occurs, we've advanced the conversation about an HSA as a long-term savings vehicle.

The whole reason to be talking about this together is the more that you do that, the more likely it is that individuals will understand that an HSA is an incredibly tax-efficient place for first dollar of their long-term savings.

And so from our perspective, there are multiple cross-sell opportunities here, and that's what really got us excited about it.

And again, I think we're trying to do it in the right way.

So they'll probably be a little patient but that's kind of what we're interested in.

And I think over time, we'll look back and see this as having been something that really helped us.

And lastly, I'd say it -- also, I think from a competitive perspective, if you look at our competitive environment, many of our competitors, as we've talked about before, do not have terribly well -- in addition to the absence of proprietary platform, don't have terribly well-developed or any custodial or investment capability.

And if this is what the market ends up or some subsegment market ends up wanting, I think that's a real challenge for those competitors.

And we'll see how they react.

But certainly, it's something we thought -- let's get way ahead of this thing.

It makes sense for the consumer.

It appears to make sense for some segment of the employer market.

We can be flexible as heck about it in -- as we learn about the markets.

And I'm certain we'll learn something, and I'm certain the investment will pay off for our shareholders.

And our final question comes from the line of Steven Wardell with Chardan Capital.

So I'm wondering about your selling season.

Can you give us your freshest take on how the selling season is going?

Where are you in the selling season?

And are you seeing any qualitative changes, like employers wanting to promote HSAs to employees more or employers shifting to total replacement more or employers willing to add cash to the HSA balance each year more?

I think mostly what we're seeing is confirmatory.

So if I go back to that point from the very beginning about -- and I'll ask Steve to comment here as well, about you can have head fakes in one direction or other, but mostly, people will continue to do what makes sense.

And so I can't say that we're seeing dramatic differences in one direction.

I do think the employers have become -- I think one thing you do see is the employers have become more savvy about understanding how to communicate at the same time to their spenders and to their savers.

I think for a long time, the employers really just focused on their spenders and they're beginning to include a lot more -- they're beginning to want to include.

And certainly, we're in a great position to provide a lot more information as well as, in some cases, a capital A, Advice, on the saving side.

And so that is something that we see as a positive development to the market.

But other than that, I think the data that you see out there just say continued growth.

People continue to turn the dials in the right direction and full speed ahead.

And Steve, what's your thoughts?

I think that's right.

It used to be that this was a decision that was maybe made a little bit more of a junior level in the human resource function of the company.

I think because of the link that we've been promoting to some of the other retirement accounts, it is starting to become more of a high profile decision, which is good for us, because I think that's once people -- they do a very thorough review of our capabilities and certainly everything we put into our investment in security and redundancy and just being one of the leaders, I think clearly, we shine really well in that situation.

So I think it was frustrating a few years ago concerning our salespeople where they would say, yes, they just said they're going to go with a local bank or something like that.

But now, I think most are realizing -- and more and more banks have exited, too.

I mean, the banks tend to be realizing this was fairly sophisticated work, and so that's allowed us to have more look than maybe historically we would have.

But as far as, we're going to push everyone in the full replace, as much as we love for that to happen, I think for the large employers, they'll still given options.

They tend to highlight the benefits of the HSAs and then allow us to come in with some of our support tools and technology and things like that as compared to the economic benefit of HSA to any other plan, but it's not like this full scale, everyone's going to have an HSA in this company or else.

We don't see that very often.

Maybe I'd add one more comment, which is one just kind of looking at the figures.

The demand for education resources has gone up along with that greater savvy and sophistication.

So that could be anything from kind of -- let's say, you're a 20-person group and you're coming to us with one of our health plan partners.

A health plan partner branded, sort of open enrollment-in-a-box type system so that you, as an employer, can get yourself really educated and educate your team members.

And on the other end of the spectrum, it's more requests for speakers, more requests for different webinar-type activities, more requests for -- frankly for year-round education.

That's probably one of the big things that you see as a direct result of the employers paying more attention and also realizing that they can make a year-round difference.

So we do see some exciting opportunities there, some ways for the investments that we're making in data-driven education I talked about a minute ago on the health side of things, but they can make a difference around the product as a whole in terms of having those education dollars be spent, real efficiency, driving outcomes and so forth.

And I'm showing no further questions at this time.

I would now like to turn the call back over to Mr. Jon Kessler for any closing remarks.

Yes, thank you.

Speaking of hurricane shutters, I did want to just close by noting that.

As I talked about a few minutes ago, we always feel a little bit awkward.

We do these calls and we're in some conference room that maybe cost some money, I don't really know.

But it's the work of 900 people out there at the company and then thousands more at our health plan partners and employer partners and so forth to get educated and get ready for an open enrollment season like the one that we're getting ready for now.

And in the middle of all that, I wanted to note with thanks and gratitude that our team members have put a portion of that spirit to focus for our members and partners that are affected by Hurricane Harvey.

And whether that's donations and the like or as the little things like getting money to someone who isn't going to be getting that card in the mailbox because the mailbox is not there anymore or whatnot, this has required real effort and good judgment on the part of our team members.

And we very much appreciate it as well as the work of our partners.

And I'm sure that every one of you are doing something similar, whether it's for family or friends or colleagues or customers, and every little bit helps.

So one last thank you.

And with that, I wish everyone a great start to the fall and welcome back from The Hamptons or wherever it was you came from, and we're all getting back to work here for the fall.

So thank you.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Everyone, have a great day.