Healthequity Inc (HQY) 2023 Q4 法說會逐字稿

Good afternoon, and welcome to the HealthEquity Fourth Quarter 2023 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Richard Putnam. Please go ahead.

Thank you, Gary, and happy first day -- first full day of spring to everyone, and welcome to HealthEquity's Fourth Quarter and Fiscal Year-end 2023 Earnings Conference Call. My name is Richard Putnam. I do Investor Relations for HealthEquity. And joining me today, I have Jon Kessler, who is our President and CEO; Dr. Steve Neeleman, our Vice Chair and Founder of the company; and Tyson Murdock, the company's Executive Vice President and Chief Financial Officer.

Before I turn the call over to Jon, I have 2 important reminders. First, a press release announcing our financial results for the fourth quarter and fiscal 2023 year-end was issued after the market close this afternoon. The financial results in the press release include the contributions from our wholly-owned subsidiaries and accounts that they administer.

The press release also includes definitions of certain non-GAAP financial measures that we will reference today. A copy of today's press release, including reconciliations of these non-GAAP measures with comparable GAAP measures and a recording of the webcast can be found on our Investor Relations website, which is ir.healthequity.com.

Second, our comments and responses to your question today reflect management's view as of today, March 21, 2023, and will contain forward-looking statements as defined by the SEC, and that includes predictions, expectations, estimates or other information that might be considered forward-looking.

There are many important factors relating to our business, which could affect the forward-looking statements made here today. These forward-looking statements are subject to risks and uncertainties that may cause the actual results to differ materially from statements made here today. We caution against placing undue reliance on these forward-looking statements, and we also encourage you to review the discussion of these factors and other risks that may affect our future results or the market price of our stock, and they are found in our latest annual report on Form 10-K and subsequent periodic reports filed with the SEC. We assume no obligation to revise or update these forward-looking statements in light of new information or future events.

At the conclusion of our prepared remarks, as Gary just mentioned, we'll open up the call for Q&A, and we'll turn the time over to him to instruct us on how we do that.

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

Jon, over to you.

That was fun that last part. Good afternoon, everyone, and thank you for joining us. I am going to report on key metrics as always, and then discuss management's view of fiscal '24 in light of current conditions. Tyson similarly will touch on Q4 and fiscal '23 before detailing our revised guidance for fiscal '24. And of course, Steve is here for Q&A.

For fiscal 2023, we are pleased to report double-digit year-over-year growth across revenue, which is plus 14%, adjusted EBITDA, which is plus 15%, HSA members plus 11% and HSA assets plus 13%. Total accounts grew 4% and bit muted by CDB underperformance and a change in methodology with no revenue impact.

HealthEquity ended fiscal '23 with nearly 15 million total accounts, including 8 million HSAs, more than 22 billion in HSA assets, nearly 1 million new HSA opened in the year, record numbers of clients and network partners, strong year-end service, thank you team, and #1 market position. And so as a result of all that, we are able today to raise our outlook for fiscal '24, which Tyson will detail.

We expect revenue to again grow double digits, EBITDA growth to accelerate to around 20% and even faster growth in non-GAAP net income and a return to positive GAAP net income, which is good.

Our outlook factors in HealthEquity's inherently strong visibility to future performance as well as our belief that the current crisis underscores the valuable stability of HSA balances, combining as they do, the stickiness of individual small balance accounts and individual tax advantaged accounts.

While U.S. commercial bank deposits fell 0.9% in the first 2 months of calendar '23, for example, HealthEquity's HSA cash grew by 6% in that same period, and that growth has continued through the banking crisis that began on March 8. Meanwhile, overall job creation continues its strong rebound from pandemic lows, which contributes to new HSA openings.

As Tyson will detail, our outlook does reflect current interest rate expectations, and a more neutral rate of job creation going forward. And of course, we're closely monitoring the condition of bank and credit meeting participants in our basic rates program, insurers in our enhanced rates program, bank holders of client held at CDB funds and holders of HealthEquity's operating cash to assure that all continue to meet our strength thresholds.

With that, I will turn it over to Tyson to detail the results and guidance. Mr. Murdock.

Thank you, Jon. I will highlight our fourth quarter and fiscal year-end GAAP and non-GAAP financial results. And there's a reconciliation of GAAP measures to non-GAAP measures to be found in today's press release.

Fourth quarter revenue increased 15% year-over-year. Service revenue was $114.2 million, up 2% year-over-year. Custodial revenue grew 44% to $83.5 million in the fourth quarter. The annualized interest rate yield on HSA cash was 211 basis points during the fourth quarter of this year, which brought our full year average to 190 basis points.

Interchange revenue grew 10% to $36.1 million. Gross margin was 57% in the fourth quarter this year versus 52% in the year ago period. Net loss for the fourth quarter was $0.2 million, which rounds to $0.00 per share on a GAAP EPS basis.

Our non-GAAP net income was $31.3 million for the fourth quarter this year, and non-GAAP net income per share was $0.37 per share compared to $0.20 per share last year. While higher interest rates increased revenue, they also increased the rate of interest we pay on the remaining $341 million Term Loan A to a stated rate of 6.3%.

Adjusted EBITDA for the quarter was $73.6 million, and adjusted EBITDA margin was 31%. For the full year of fiscal '23, revenue was $861.7 million, up 14%. GAAP net loss was $26.1 million or $0.31 per diluted share. Non-GAAP net income was $114.5 million or $1.36 per diluted share. And adjusted EBITDA was $272.3 million, up 15% from the prior year, resulting in 32% adjusted EBITDA margin for the fiscal year.

Turning to the balance sheet. As of January 31, 2023, we had $254 million of cash and cash equivalents with $925 million of debt outstanding net of issuance costs. This includes the $341 million of variable rate debt I mentioned earlier.

We have an undrawn $1 billion line of credit. So we have a strong balance sheet with the reoccurring revenue model.

And now we expect the following fiscal '24, we expect to generate revenue in the range between $960 million and $975 million, and we expect GAAP net income to be in a range of $0 to $11 million. We expect non-GAAP net income to be between $152 million and $163 million, resulting in non-GAAP diluted net income between $1.74 and $1.87 per share based upon an estimated 87 million shares outstanding for the year.

We expect adjusted EBITDA to be between $320 million and $335 million. As a reminder, beginning in fiscal '24, we are basing future interest rate assumptions embedded in guidance on forward-looking market indicators such as the secured overnight financing rate and mid-duration treasury forward curves and Fed funds futures. We now expect an average yield on HSA cash of approximately 230 basis points in fiscal '24, up about 40 basis points from last year.

We continue to assume that the average crediting rates our HSA members receive on HSA cash will increase by 5 basis points per quarter in fiscal '24. And finally, our guidance reflects the expectation of higher average interest rates onn HealthEquity's variable rate debt versus last year, consistent with the current forward-looking market indicators.

We assume a projected statutory income tax rate of approximately 25% and a diluted share count of 87 million shares, which now includes common share equivalents as we anticipate positive GAAP net income this year. As we have done in recent reporting periods, our full fiscal 2024 guidance includes a reconciliation of GAAP to the non-GAAP metrics provided in the earnings release and a definition of all such items is included at the end of the earnings release.

In addition, while the amortization of acquired intangible assets is being excluded from non-GAAP net income, the revenue generated from those acquired intangible assets is not excluded.

With that, we know you have a number of questions. So let's go right to the operator for Q&A.

(Operator Instructions) Our first question is from Anne Samuel with JPMorgan.

Congrats on a terrific quarter. My first one, I was just hoping you could speak a little bit to the enhanced rates product. I don't think I heard you say what proportion of deposits are in it now? And just maybe where is that expected to go over time? How are you thinking about that as maybe a potential tailwind for yields or maybe just a stabilizer?

Yes. Thank you for asking the question, Anne, and it's good to hear your voice. So we ended the year north of our goal of 20% of our HSA cash and enhanced rates. And I think just as importantly, we ended the year with a growing set of partners in this space amongst the large and highly-rated insurers. And -- so we think that both the demand is there for this and then the supply, if you will, from our members, is there for it. And so our expectation continues to be that this product is going to grow, that it's going to grow.

I think we've said elsewhere, something on the order of about 10% of our HSA cash a year, and that will depend a little bit on factors like the underlying speed of the HSA cash growth and whatnot. But I think that's a good conservative estimate. So maybe we'll be -- we'll certainly be north of 30% by the end of this year.

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

That's really helpful color. And then I was just maybe hoping you could touch on how some of the recent banking volatility might impact your business? I realize you don't have any depositories that are impacted, but you often speak about the primary driver of yield being competition for deposits. So just wondering how this might impact that?

It's interesting. You've got it exactly right. What we saw during this period is the value -- what we've seen during this period is the value of stable deposits and that value of being a good, in our case, a good customer of these depository institutions, right? Whereas well reported, you saw these banks and other institutions that were heavily dependent on corporate deposits, see big flows. That's not what we saw. Our members were extremely steady for all the right reasons. These are long-term tax-advantaged accounts. their small balance, they're FDIC insured at the member level, et cetera, et cetera. And there are real penalties and so forth to moving your money.

And so people -- what I think this crisis on the banking side has kind of showed is that all deposits aren't equal, and we offer a great source of funds for institutions that have real loan demand, not sort of created in money markets or the like. And that's who we do business with, and we feel really good about how we've responded in terms of both how our members have responded. I mean of course, as a team, we went into the same -- with all the unknowns of 2 weeks ago, we went into the same kind of crisis management mode as everyone else did, to make sure that things were okay.

But I can't tell you how much this demonstrates to us. And I think ultimately to our partners across the banks and the insurance companies that this is -- why this is a very stable source of liquidity when they need it.

The next question is from Greg Peters with Raymond James.

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

Yes, I mean, I think fundamentally, Greg, the things that you would be concerned about -- I mean, the first thing that we are concerned about, it's not -- I don't even get into issues of asset quality. I want to start with issues of whether the -- for the insurer, whether the liability side of the balance sheet is strong, meaning whether these are truly illiquid and so forth. And so there's real good coordination. That's had an impact on the kinds of insurers that we want to do business with as we start this program.

As you well know, we have largely steered away from the folks that are relatively newer into the space, that have gotten in on the back of private equity money accumulating, that kind of thing and have tended to focus perhaps at the expense of some premium on return, have tended to focus on winning partners who have been in the insurance business across multiple lines for not just tens of years, but as you know, in some cases, hundreds. And that served us well here.

So we obviously do monitor -- the nice thing about the insurance side is we get a ton of data and we get it in rough real time. And so we have been able to monitor very closely things, the kinds of issues that people have talked about in the bank space with regard to both the liability and asset side of those institutions, and they have performed extremely well exactly as we would have expected.

I think where you're seeing more stress is, I think, in institutions where the growth of the balance sheet is a relatively new phenomenon. And so not dissimilar, I think you've heard me say before on the bank side, where we get very cautious when someone is looking to us as a means to sort of launch a business plan on the bank side or the regulators don't want us to be necessarily the source of rapid balance sheet growth. They want us to be the source of stability. And I think we've sort of taken the same approach with the insurers.

And again, I think that's serving well from the perspective of our goal, which is ultimately getting the most for our members and for us, but in the context of stability. So it's a great question, and it does seem like it's playing out in the way that we would want thus far.

Well, okay, that's helpful. I guess the other question that comes to mind, there's the credit side but then there's also the business side of what's going on. So can you -- as we think about the selling season for HSAs and the other accounts, can you talk to us for a minute about how you might have exposure to different industries, say, the banking industry versus start-up tech companies versus you have almost 8 million HSAs. Can you give us a sense of how that spread across different subsectors of the economy. And when we think about the selling season, if there's layoffs in the tech space, is that going to affect your outlook more disproportionately than if there are layoffs in the banking space, et cetera.

Sure. Maybe I'll make that a 2 parter, Steve. I appreciate if you would chime in here, Steve is in Washington today, and I assume it's nonetheless yet. We're not on TikTok here, so I assume you can none the less (inaudible) on this call. Maybe you can talk a little bit about how our prospects and our health plans and the like have reacted to what's going on in the last few weeks. And then I'll sort of address the broader client concentration question.

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

And so Greg -- and then you know with our 130 health plan partners and another 40 different types of partners. We have such a wide variety that we're not really that concentrated in any specific industry. It's pretty amazing, honestly. There's been -- I think if you just look across the sectors or types of businesses, I mean, we have everything from hospital systems, and we do have some tech but not thankfully, the tech companies we've been working with have not been heavily adversely affected.

And so we can never say never that it's going to impact us, but we have seen this, and I think we're pretty well diversified and hedged from that perspective. And we just keep hearing the same thing come back -- that keeps coming back around, which is, yes, a recession could be in front of us, but this is the best time to help employees understand that when dollars are tight, let's get you into a lower-cost premium plan, let's get your tax rate lower and that's how you start saving. And so we've seen, Greg, a strong RFP season as we're starting to gear up as we ever had. I think that's consistent with what we were able to do last year, having a record sale year. I mean there's almost 1 million health savings accounts.

And so look, I mean, we're always, I think, productively paranoid around HealthEquity. You've known us for a long time. That's the way we roll. But on the other hand, we're -- I think we're pretty enthusiastic that we're going to keep the momentum going.

Jon, do you have other stuff you want to add, it sounded like?

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

Great. I appreciate the answers. Yes?

Thanks man. I haven't said one thing to, in any way, tease you. I'm playing it 100% right down the middle.

I was just going to add for the clothing requirement for your Investor Day, and maybe we can include some Bermuda shorts that seems to be pretty (inaudible).

It's funny. You should mention that. That will be in the invite. Suffice it to say, it will be in a warm location, right? Got it, a warm summer location. I mean it's Salt Lake City. But nonetheless, I'm letting that cat out of the bag. We're doing Salt Lake. We're getting the Utah people out to -- it's going to happen, it's going to be fun. It is going to be fun, by the way. It is going to be fun. So we hope that folks can join us.

The next question is from Sean Dodge with RBC Capital.

Jon, just going back to your comments about the benefits or the stability of your HSA deposits and those becoming increasingly attractive given all that's transpired. Just maybe to put a finer point on that. Is that something -- is this increasing attractiveness? Something you can monetize going forward in the form of generating higher yields on those types of placements. Kind of all else equal, can you get a little bit more of a premium because of that?

I think the answer to your question is -- I mean, the answer to your question is yes, could we keep on being all else being equal. I sort of look at it like -- or I guess I'm maybe stealing the words out of the mouth of our newly appointed Treasurer and saying, this is making my introductions to institutions that the company has dealt with over many, many years a lot more friendly. And presumably, that good feeling (inaudible). I also think it's true that the fact that we were not in the mode of moving this money around willy-nilly over the course of Thursday and Friday of the week of March 8, it's not that we couldn't have and it's not that we didn't pay very, very close attention what's going on.

But ultimately, the fact that we were able to do that, I think, breeds confidence and breeds is the kind of thing we want to be as a partner. So when those renewals come up, those are likely to be more effective renewals. So I do think you make friends and/or lose friends very quickly in these moments, and you shouldn't be making and we're not making decisions on the basis of friendship, but when something works from the perspective of safety, when safety is needed, people don't forget that.

And so I do think, ultimately, when you think about the long-term durability of the premiums that we've generally been able to earn on relative to what banks have been willing to pay elsewhere, this is a really nice event from that perspective.

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

No. I think there are 2 factors, Sean. One is that we don't want to create a sort of uneven ladder, if that makes any sense, where we to, let's say, have -- well, 3 factors. One is we don't want to create an uneven ladder. That is to say were we to, let's say, have a movement of 30% or 40% of our deposits in 1 year. You would then be asking us x years from there or wait, have we created uncertainty about the redeployment of those assets? And we don't want to do that. That's not good for how we manage the business and it's not good for our shareholders. So that's kind of issue one.

Issue 2 is that we are learning as we go, and learning is, I think, as are our partners. And so that is -- it's probably fair to say that the demand for this program today among would-be partners is higher than it was a year ago. Well, part of the reason is because it's existed for this long and people have watched the results and there's a level of confidence in those results.

The last factor, which is, of course, relevant is that the source of these assets in addition to new members' contributions to HSAs is existing members. And so we also have to manage our FDIC commitments, meaning our bank deposit commitments. And so we were able to -- in this cycle, we were able to deploy less into banks than we would have without the existence of enhanced rates. And again, that allowed us to be, I think, appropriately choosy, both in terms of economic return and other factors. But -- and so that -- but that's also a bit of a breaking factor too. That is to say we want to make sure that we still have plenty of liquidity to meet all of our minimum commitments there.

So within those 3 parameters, which are really, in my view, the key to this, ultimately, we feel like we're moving at pace. Member interest has been, no pun intended, has been there the whole time. And I think if we were devoting -- if our sole objective was to move as fast as we could, we would be doing so with -- we'd be moving faster with a heavy marketing emphasis, but I don't think that's what we need to do right now. We're happy to have a -- with this element, a multiyear tailwind that will contribute to even longer-term stability.

The next question is from David Larsen with BTIG.

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

Tyson, do you want to take those?

Yes. So from a revenue perspective, when we gave guidance back on December 6 and you look at, for example, the average CD rates, jumbo CD rates and you look at things like LIBOR, SOFR rates, they were actually lower then. So we got a tailwind from those that we would be putting into the yield rate as well as to the revenue top line. And then just going back down to the plan from a perspective of profitability and the slowdown of those custodial revenues. That's why you see the bottom line lift up as well.

And so you have essentially that running down to the plan. And we knew that would be the case and believe we've called it out at that time as well.

And then the second question was the...

Interchange.

Interchange, yes. So that's...

Quarter-over-quarter sequential energy.

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

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

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

I think, David, one of the things about the nature of our fiscal year being January 31 is you got that January month where people begin a new plan year and have met their deductible and so pretty much everything is out of pack.

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

So if I look at our -- I'll take this one. If I look at our overall custodial assets, you can divide that first into 2 pies, about $14 billion of it is what we call HSA cash and the remainder is invested. The invested assets are obviously not FDIC insured, they're in mutual funds and the like at the member's discretion. So I think you understand that.

If I look at the cash component, it has 2 elements. The bulk of it is in our basic rates product, and all of those funds are in FDIC member institutions or NCUA, I guess, member institutions that offer pass-through insurance to our members subject to the usual $200,000 limit, which generally an HSA has not been reached almost exclusively.

And then with the enhanced rates product, these are not FDIC insured, they're not deposits. These are, as we've talked about before, these are group annuities that are insured by highly rated insurers that are again entered into at the direction of the members. So that's sort of the breakdown there.

And I guess I would add to all of that, what all of those have in common is we do not bring -- our members aren't paying us to be a principal risk taker. We are not a principal risk taker. We don't bring a principal risk on to the HealthEquity balance sheet.

The next question is from Stan Berenshteyn with Wells Fargo Securities.

I'd love to get an update on your MaxEnroll product. I think it's probably been out for a year or so, if I recall correctly. I'm just wondering how widely has it been adopted by your clients? And do you have any sense how much of your member growth this past year could be attributed to MaxEnroll?

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

And I think we did well this year. We're still, I would say, in the -- we may be beyond the nail it and now in the scale it stage, but we're still in the early part of the scale it stage of this thing.

And there are good reasons for that. We still have, I think, work to do to make the product truly effortless for our clients, to have it more deeply integrated. What we found this year was where we did the best was where we were more deeply integrated in terms of data with other things that our clients were doing within open enrollment.

So where we understood precisely -- from a data perspective, we could understand precisely what their open enrollment dates were, when things would begin and end, so we could show people timers and those kinds of things, which seem trivial, but they created more immediacy about action, and that was extremely helpful, where we understood what our clients were trying to do in terms of the pricing of their various health plans. And so we could speak that language within this stuff or give them the tools to do so. That was extremely helpful.

So I think we did reasonably -- so we did well this year. There's more gain to be had.

And then the second part of your question, which was how much does this to contribute? I think I've estimated elsewhere that if you look at the gains that we got from existing clients that were over and above what we might have expected without this product. It probably gave us somewhere between 50,000 and 100,000 new HSA openings over the course of this cycle. And that's probably maybe a little bit of an exaggeration because obviously, there's some favorable selection with these clients where people who are really interested in growing the HSA base are more likely to really get aggressive with this and use it to its fullest extent. But you kind of get the idea. So it was absolutely a material contributor to the overperformance that we saw this year on a year-over-year basis.

The next question is from Sandy Draper with Guggenheim.

So I guess it's going to try to be one question, but I'll sort of wrap a couple of things together. When I just -- when I look at the cash flow, you're starting to see an improvement in your cash from operations. Capitalized software is moderating. You did step up a little bit on M&A. But if I think about your guidance, your net income and your EBITDA is up. Your -- if I look at the add back some of the cash add-backs integration costs are going down. So it looks like net-net of all that is free cash flow and cash you have is looks like it's going to be pretty good and hopefully sustainable. So when I think about the M&A environment, what's that like? But then also, I know Tyson indicated or I think you said 6.3% is the stated rate maybe on the floating rate debt. How are you thinking about debt paydown versus M&A or any other internal investments in balancing those 3 things out?

Awesome question. Thank you. It really is, we were -- this is actually -- we probably spend a half hour in our press, just kind of thinking about how to answer this in such a way that like it's -- like sometimes you have things where you want to answer and you like, but you don't want to like give them everything, this is one we're like, I want us to give you everything because it's so -- it's such a fun, interesting and important capital allocation problem. But I'm going to resist doing that. But -- because that's what the team told me to do.

But a couple of thoughts. First of all, the premise is right. That is to say that if you look at fiscal '23, we converted EBITDA free cash flow at a rate pushing 60%. That rate is coming up, were wide because integration expenses are coming down, and that was a big add back, et cetera, et cetera. But as you say, one break on all of that is the interest on the relatively small, but nonetheless, they are a variable portion of that. So you've got all the right factors that we're looking at in terms of where to deploy capital here.

I think if I look at the M&A environment, a couple of things really strike me. The first comment I've made elsewhere, which was we are absolutely not in a rush to do anything from an M&A perspective material that is in the nature of let's go horizontally expand to this, that or whatever in the way of existing established markets.

We're not in a rush to do that, both because -- we think that our clients aren't demanding that we do it, that valuations are plenty fulsome out there and that we can deliver more shareholder value at this point in time through the work that we're doing on the organic side and with partners to kind of develop product that isn't established out in the marketplace. And so our inclination is not to go out on the sort of horizontal side and deploy capital there.

If I look at competitive consolidation, you know part of my answer, which is we're always interested in attractive transactions that have high IRR for our shareholders.

I think for all of the reasons we talked about, both at the beginning of the call and in the first answer about these deposits being very steady for the banks at the moment. I am less sanguine even than I was a few months ago that like there's going to be a material transaction that's going to develop in that area. I just -- that is how it is. And I think that's totally fine.

There's no reason for us to run around pricing those transactions into the market or the like. And it's a reflection of the quality and steadiness of the underlying business. So I'm -- that being said, we do have to -- we then are looking at and should be looking at like what's the purpose of maintaining that -- the outstanding TLA and its current size, when we obviously have the capacity should we need it for pretty much anything that we would contemplate and we are looking at that. So I probably did just give you more than they told me to give you, but that's the full answer.

The next question is from George Hill with Deutsche Bank.

I'll say (inaudible) because Sandy took my cash flow question. So I guess what I'll roll into is maybe talk a little bit about expectations for the CDB business in '24. Is that something that we think shrinks again next year? Or is it poised for stability in a rebound? And I'll have a quick follow-up.

Yes. You can't just claim credit for Sandy's question. That doesn't fly with us. But...

Jon, I had a cash flow question here written out on my notes and we basically asked (inaudible).

So look, on CDB, I -- as folks will recall, I was hopeful that we could put a black single-digit on the boards coming into '24. We didn't quite get there because COBRA remains weak, and that's probably the biggest problem. And we are going to have to really look at it and understand a little better or understand as well as we can, what our levers are. I think what is fair to say is that our guidance with regard to revenue generation in the current year reflects a level of conservatism on this topic.

But that -- it is pretty clear that we know what to -- but that having been said, the sales have actually been pretty good. Our challenge, George, has been the platform movement and all of that. And if I could be convinced as well as the regulatory issues that kind of brought us up and then brought us down around the national emergency. And if I could be -- if I were convinced that all that were behind us and that we -- that not just we but employers had fully digested the implications of all of that. I probably feel more confident in giving you a view that I'm not just hopeful, but comfortable that from a sales perspective, we will be able to put up a black zero -- a black number here. It will still be a single-digit number, but a black number.

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

Understood. And if I can have a real quick follow-up. I guess, are you seeing anything in benefit construction and benefit pricing and the things that I'm kind of leaning on right here and thinking about like what's going on in the insulin market where you're seeing much lower out-of-pockets for patients on insulin. I guess, are you seeing any of these changes either in benefit pricing or benefit design that has the capability to either -- I'm thinking about it could like lower your interchange fees but it might increase your average balances as people dip into their HSAs less as they're out of pocket fall? Would just be interested in how you're thinking about kind of those parts of the market and kind of how those pieces move together?

I'll comment on this and then invite Steve to comment further. I personally think that this stuff that's going on right now with insulin as an example, is -- and I'm sure I'm stepping on somebody's toes here, but I think it is both fantastic and incredibly realistic, right? What it's doing is it's giving people certainty and certainty is really important for people from -- we talk about being in the business of connecting health and wealth. It is hard to talk about that in a world where people think that every health care transaction that they have, they're being cheated by somebody on it.

And so my hope is genuinely that from a plan design perspective and, frankly, from a legislative perspective, and we're -- maybe where Steve will comment a little bit, we're -- these are issues that we're starting to weigh in on that we're able to bring people greater certainty with regard to the routine kind of medications and the like that are part of their regular daily life.

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

Steve, do you want to comment further on this?

Yes. I want to also, George, say that Jon stole my answer, just for your question. No. But look, I think that, as you know, George, we've known you for now, goddammit 9 years when we met you, right? And Consumers have always been #1 to us. And we've had questions that are similar to the ones you just asked, which is like, "Why do you always tell people about these investments when you make less yield on the investments or when yield on the cash?" And the answer is because the consumer will always be #1 in our book. And it's because consumers need to help. And so one of the things I did talk to the legislators today about was where they stand on things. In fact, I gave an article from NPR to a (inaudible) that talked about a very insulin question you just asked.

And I asked them, what do you think about where we're standing with these transparency requirements for hospitals and health plans who are some of our great partners, hospitals and health plans. And it's great to hear that there's actually some bipartisan kind of girth behind getting consumers the right information they need to make better choices.

Now whether that plays out in the market where consumers just now have the ability to go get a lower-cost insulin because price drops by 75% because of new entrants, which happens to be one of our partners. It comes out with a new insulin. That's wonderful. Or if it manifests itself a little bit differently that Jon was alluding to, which is there has been some progress, as you know, getting consumers (inaudible) Jon's words certainty on cost, for example, under the Affordable Care Act consumers if they're diagnosed with high cholesterol, they can get statins for free, right? No cost share.

And so it's certainty. Their health plan pays for it. And obviously, the health plans can negotiate a great price on that. I think that there's other opportunities out there. And so as legislators have looked at it and said, how can we help people be more healthy? Is there a way to help have better drug prices can be far away behind some of these initiatives. It completely benefits us. To your point, there may be lower upfront spend, but we've always said we'd make sure that people have more money in their health savings accounts, longer and then they can spend it next year.

And at some point they start getting older and the health care costs start to go up. The average age of cancer in this country is in the 60s. Those are going to be times when they really need to spend this money when they have those types of events. And we're going to be there for them. And so I think you will always find us completely comforted by expanding regulations to be able to do things like better transparency and lower-cost drugs and things like that.

So we're going to keep doing that, and we're going to keep innovating to get people the right information at the right time so they can make the right choices with the way that they both save and invest and spend their health care dollars.

And let me say one more thing for those who are wondering like what the hell this answer and question has to do with our revenue streams. There -- in addition to the sort of more obvious answer that is it makes the health plans that people choose and then choose to bring to us bring dollars to us more appealing and there are also some more direct opportunities here.

Our clients at the employer level, our health plans and our partners at the broker level are absolutely -- this whole discussion around bringing -- it's not -- I mean it's transparency. But it's also simplicity to some of the more routine pharma items to things like maternity to mental health where we don't want people not using these services not because they can't afford them because they don't understand what they cost and they're scared.

We don't want to be in that circumstance, and there are easy things that relative to rocket science, there are easy things that can be done in plan design and that's helping employers do those things and helping clients do those things and helping our partners arrange those things, there are interesting top line opportunities for us. But right now, we're in the exploratory phase and seeing what -- where we have the right to win and where we can partner with others and whatnot. But this is an area of real opportunity for us.

The next question is from Mark Marcon with Baird.

I've got 2 questions. The first one is with regards to the number of HSAs that were added in the fourth quarter. Can you kind of break down both for the fourth quarter and for the year, the percentage of new HSAs that were a function of brand new sales to new employer partners versus what percentage was due to new hires and to what extent may have the new hires slowed down in the fourth quarter relative to earlier in the year?

Yes. So let me -- without -- you always ask questions in a way that I'm not going to answer them exactly that way, but I'll do my best. If you look at it, and you will notice on a year-over-year basis that we were ahead in earlier quarters of the year. But as the year went on, right, in terms of new adds, right? We were close to last year. I think in Q4, we actually had more new adds in the prior year than last year.

And someone could bang us on that, except that we said throughout the year that, again, particularly at the beginning that, hey, part of what was going on here was new -- was essentially job formation, right? And job formation, as you know, did slow down a bit in Q4, particularly calendar Q4 and relative to earlier part of the year. And so I think that was reflected a little bit. The sort of -- so that was reflected a little bit in the data.

And then again, apropos the commentary I made about guidance, right? We've tried to be, I think, very realistic about as we look forward, let's look at -- let's guide with the idea of a neutral view of job creation. Neutral doesn't mean 0, it doesn't mean negative number, it means more neutrally 100,000 a month, that kind of thing in terms of what the broader economy is doing. So that -- there is the connection there, Mark, that you -- that the question implies.

That having been said, across both HSA and our CDB business, new logo and new client within existing health plan and retirement recordkeeper partner was a very important part of this year. We looked at -- and what's nice is today is that more of your new logos are actual -- in the HSA world are HSA takeaways. Of course, in our world, many of those are also cross-sells. We have existing products with them. Some of the folks that -- if you look at the case studies that we talked about over the course of the latter part of this year, Pfizer being an example, right? That was -- that's an example of a company that never offered HSA. So there's those.

But then there are also examples of like they were offering it, right? They weren't satisfied with a partner that was really looking at it from the perspective of the needs of every member, maybe just looking at the top 2% or just looking at a way to just pay health care claims without regard to how that could help the consumer either way, we're a better option than that. And so that's the takeaway business.

So I -- it is probably a fair statement to say that in the earlier part of the year, right, existing -- basically, employment growth at existing firms was a bigger component than in prior years, and that kind of normalized itself as we got towards the end of the year.

And I mean you continue to gain share and you continue to win more and more than your fair share. So I think that's fairly clear. I was just trying to dimensionalize what the year-over-year trends were looking like?

The relevant point is when people go into next year or now this year and they say, oh, you sold almost 1 million HSAs. Is it going to be 1.1 million? I kind of say the same thing that we let last year, people said you're going to sell my 900,000, you just going to sell 1 million. And if I rewind a year ago, we were not thinking that we would have a level of robust employment growth over the course of calendar '22 that we actually did. And so we were sort of trying to point that out to folks. And I'd make the same comment this year, just starting from a slightly different point. And I think people are more on board with the idea that employment growth is going to have to moderate from here. The government seems to want to make that happen. But it's kind of the same point.

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

Well, I'm going to focus on service, and I think there -- Mark, the truth is we have work to do. I'm not -- I appreciate that on a year-over-year basis, we boosted what you might call service gross margin by 11%. That's also because the prior year just sucked. At my life, I don't want to say that. And in my view, we still have a ton of work to do here. What's interesting and important and for those who are close observers of our hiring and so forth, what you'll see is that there's some of that work that's very -- I'm going to call it, commercial and operational.

So as an example, there are some areas that now that the dust has settled from the pandemic that there are fees that we have to look at, and we have to pay reasonable fees for reasonable work. So there are elements of, for example, the COBRA business that we're looking at and working with our partners and saying, guys, here's how this has kind of sorted out, right? Things are different than they were pre-pandemic. Let's address that. And obviously, labor costs have risen too, right?

But there also is a ton that we have done and can do with tech, and I'm going to give you 1 example. And like I'm not going to -- I don't have a ChatGPT story to share with you, so you can be relieved in that regard. I'm not going to try and suggest that we ginned up some initiatives in that area. But what is true is that if you look at our volumes during peak -- our peak month, which is January, right, we and I mean, they, the team just delivered an outstanding month.

And part of the reason to be able to do that is that chat handled, not ChatGPT but our chat functionality handled 30% more calls than it had the prior year. And part of the reason that makes things easier is because it turns out that chat is more effective at inserting -- I'm not going to call it AI, I'm going to call it computer-generated answers than you can do in the context of an IVR or the like. And so -- and there is a lot more juice to squeeze there and plus which our members from the perspective of SAP have loved that stuff.

And so it does, to some extent, reflect the kind of changing demographics of the membership. The highest uptake rates of HSAs are among millennial. And so that's a bigger part of our base. They want rapid answers. They get them. But I do think on the -- we tend to talk about tech from a revenue growth perspective, but there's also a ton of opportunity here. And I guess I really -- I don't want to convey in any way, shape or form genuinely like that we've accomplished much of anything other than we didn't make the same mistakes that we made last year. That is back in the rollover.

And we didn't have the same macro environment of remember, Omicron or whatever brief letter we were dealing with. So I don't think we're like at pat our back on the -- pat themselves on the back level here. We're in a place where we've got more we can do.

You mind if I just tap for one thing and just talk maybe just coming on the service level though. I mean even though we're...

Yes.

Pat on that back for just a second because we did -- I think I can tell you that was great. Go ahead, Bill.

Yes. No. I mean, look, I think -- at some level, for everything we try and do, the table stakes in our business is that when our clients, particularly our smaller clients call us up in the middle of January with something going on that we can help them and we can help them quickly. And that was a challenge in January of calendar 2022. And it was -- it's always a little bit of a challenge because everyone calls the same time but far less so. And that was both the work of our team, the work of our partners in getting clients loaded. And then the work of our operations partner sort of our word for vendor in doing their thing.

So -- and it's going to help us from a sales perspective. It already is helping us from a sales perspective as we get into this year. I mean, Steve alluded to, we've tried to get away from the quoting RFP staff, but Steve alluded to some of them. And like, look, the truth is, a lot of that is people are like, okay, you just helped me out of a jam that maybe I created in January, right? I'm going to remember that when it comes time to do my next RFP for something in February.

So again, it's obviously a very uncertain time, but it's -- this is one of the reasons why we felt comfortable with the idea that we could do what we thought we would be able to, which was come here in March, raise our guidance a little bit, just as if nothing had happened in the last few weeks. And obviously, something has happened and yet we feel like we're in really good shape.

Our next question is from Allen Lutz with Bank of America.

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

Yes. It's -- and maybe I'll invite Tyson to correct me if I'm being imprecise or if I'm going in the wrong direction here. But this is going to level out, and it's leveling out as a percent of revenue because really, because expenses that we're really -- if you look at it, where integration expenses are now -- are either not necessarily or being used for innovation. And so there are some things that muck around with it, like as you well know, as we're now well into cloud world, you get less D&A, which the good news is as you get more free cash flow conversion, right? But the bad news is that from an EBITDA perspective, it doesn't look as good, blah, blah, blah, you know all that stuff.

But -- your intuition, which is that this is leveling out is correct. And it's -- and then it's really about -- what's really important is not just that it levels out, but rather and then it can ultimately begins to decline as a percentage of revenue. But that -- it's what we're spending it on because in real dollars, this number is going up. And what's important is the shift in that expenditure from the process of integration, which was really important for us to get us to where we are today to now shifting those dollars towards really focused on our core growth platforms and our innovation on those core growth platforms.

And if you look -- anyone who looks at LinkedIn or any of these things that they can see exactly what's happening. And that is what's happened.

I just want to give Tyson a chance. Did I answer that in the way you would have?

You did great. I guess the only thing I would add is just say the way we build plans is we try to get leverage off those P&L items, P&L items, even when you think about stock comp and things like that. So that's a priority for us as a business to make sure that we're...

(inaudible)

For all of our leaders. Yes. So that's my mention.

The next question is from Stephanie Davis with SVB Securities.

You're here.

This is Anna Kruszenski on for Stephanie.

I don't like the sound of that, Anna. Go ahead.

First, I actually wanted to go back to the more elevated R&D spend on the platform. You did mention that this should start to level out. But curious if you could give any sort of outline on how you're working to modernize the platform?

Yes, you want to give your second part, too, and we'll try and hit both together.

Sure. Yes. So the second one was actually kind of also start going back to M&A piece. But private market valuations rationalizing. I was curious if there was any potential to accelerate some of these R&D priorities via M&A?

Yes. Awesome. That's perfect. So what we're really focused on, and I expect for those who -- I don't mean to like build it up crazy, but for those who attend our Investor Day, we'll talk a little more about this, and we'll bring some more people to talk about it. But we're really focused on the view that within broadly defined the world that we operate, which is ultimately about helping people we say connect health and wealth. The longer version of that is to help people manage the financial aspects of their health care.

There's the evolution of technology, the incremental use of APIs, obviously, some of the AI stuff, it creates some new opportunities that I think did not -- we think didn't exist 4, 5 years ago. And some of it is the existence of the tech and some of it is the embrace of the tech by everyone else, by others within the ecosystem. And so that's really where we're investing. And I talked earlier in the year at some other bank's conference about some of the specific opportunities, both in -- that we have here to drive both new product that's very visible to our clients and members as well as drive things in the area of the transaction or card fees around really integrating what we do into the existing mobile wallets, making some of that stuff easier and ultimately driving incremental transaction value.

So that's really where we're focused in terms of where those dollars are going, as well as the basics of completing our cloud journey and all those kind of things. But I think my take here is that we have this period of time where all of the things we've done from expanding the product set through the addition of wage and all of that, expanding our partnership base through things like the further acquisition, enhanced rates and the migration of that over the course of the next few years plus notwithstanding events over the last few weeks, what is still a far more favorable environment from a macro and rate perspective. This gives us a period of time where we can both invest in these kinds of innovations that will produce growth over time and still in the near term, deliver to you as we've done in our outlook here incremental and prematerial incremental margin improvement.

So to the second part of your question, is it plausible that some M&A is a piece of that? And the answer is yes. I think it will -- it's far more plausible that it would be in the nature of smaller enterprises where it's a little bit more like aqua hire or the like as opposed to existing $300 million, $400 million businesses. And I say that, it's not impossible. I say that because that's where I think the opportunity is for us and to create value for our shareholders right now.

I don't see the same one. I don't see the same level of rationalization within those established businesses yet. And two, that's -- our clients are -- especially in one of the reactions to inflation and the like. Our clients want more solutions that help their consumers navigate the financials of health care, right? And that's -- we already do what's great in that space that's established. It's about some of the new stuff that's out there and are there examples of folks who are out there and able to try stuff as effectively R&D labs? Yes, and we'll be happy to do that kind of stuff. But it's not going to -- that's not going to be like big draws on the balance sheet or the like. It really is a build versus buy type discussion on some of those things.

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

Man, you really cut that off. That was like -- that was Richard quality there. Thank you. Can we have you at every call -- no. so thanks, everybody. Look, obviously, I hope what you have taken from today's call is that we really feel now having been a full 2 weeks into this current craziness that if we're able to step back and look at it from the perspective of the long term of our business, this demonstrates the quality of what we do and the value of having a plan and sticking to it and ultimately, the steadiness of our business, which has always been one of the things we have promised you that is to say visibility along with growth, which we're delivering with our outlook profitability, which obviously we're delivering with our outlook. And then durable competitive advantage, which, as someone pointed out in the Q&A is ultimately a function of extending our market leadership.

So hopefully, we're doing what you want us to do. And hopefully, that's -- we sort of believe we'll get rewarded in the long term for that. And in the meantime, we appreciate everyone's questions, everyone's interest, get your Bermuda shorts now before they're spring priced, and we'll see all in -- we'll talk to you before then, but we'll hopefully see you all in Utah in the month of July.

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