Healthequity Inc (HQY) 2024 Q2 法說會逐字稿

Hello, everyone, and welcome to the conference. Please note, today's conference is being recorded.

I'd now like to turn the call over to Richard Putnam. Please go ahead.

Thank you, Rocco. Hello, everyone. Welcome to HealthEquity's Second Quarter of Fiscal Year 2024 Earnings Call. My name is Richard Putnam, Investor Relations for HealthEquity. Joining me today on the call is Jon Kessler, President and CEO; Dr. Steve Neeleman, Vice Chair and Founder of the company; the company's CFO, Tyson Murdock; and is soon to be CFO, James Lucania.

Before I turn the call over to Jon, I have 2 important reminders. A press release announcing the financial results for our second quarter of fiscal 2024 was issued after the market closed this afternoon. These financial results 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 this webcast can be found on our Investor Relations website, which is ir.healthequity.com.

Second, our comments and responses to your questions today reflect management's view as of today, September 5, 2023, and will contain forward-looking statements as defined by the SEC, which include 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 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 as they are detailed 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. One more note before turning this over to Jon, with Jim now onboard, we have rescheduled our DRAPER Investor Day to February 22. We're hoping for another great year of snow for those who want to ski on the greatest snow on earth. And we hope you all will join us either in person or virtually. Over to you, Jon.

Okay. Hello, everyone, and thank you for joining us. I will discuss Q2 key metrics and management's view of current conditions. And Tyson will touch on Q2 results before detailing our raised guidance for fiscal '24, and Steve is here for Q&A.

In Q2, the team delivered double-digit year-over-year growth in revenue, which was plus 18%; and adjusted EBITDA, which was plus 31%, HSA assets grew 13% and HSA members grew 9%. Total accounts grew 3% muted by the previously discussed change in COBRA methodology. HealthEquity ended Q2 with 8.2 million HSA members, $23.2 billion in HSA assets, and 15 million total accounts.

The team added 156,000 new HSA members in its fiscal second quarter, which is healthy, but down from the record setting Q2 last year. As in Q1, comparison to last year's blistering job growth and high turnover as well as fewer agency transfers from small banks were offset by robust new logo growth driven by an expanded network partner footprint and HR departments seeking out win-wins.

The team also added $883 million in HSA assets in Q2. I wanted to say a whopping 883, but I wasn't allowed to, so I didn't say that. And that's compared to a $272 million increase in the year ago period, which would not be as whopping, reflecting not only account growth, but also balance growth.

Despite inflation, average HSA balances at HealthEquity grew both sequentially and year-over-year, in part due to investment. 11% more of our HSA members became investors' year-over-year, helping to drive up invested assets by 23%. Remarkably, invested assets now account for 40% of HSA assets.

We continue to see more members choose enhanced rates for their HSA cash, leading to higher for longer custodial yields and we believe less cyclicality in the future. Interest rates in Q2 also gave a boost to variable rate HSA cash, and CDB client health funds. While custodial fee growth drove Q2 performance, the team also delivered modest progress on service fees, the bulk of which come from ancillary CDB administration products.

Service revenue rose 3% year-over-year, in line with total accounts. Service cost grew just 2% year-over-year, and declined sequentially by more than $4 million. As we discussed last quarter, rapid improvement in service tech continues to drive more interactions to chat and automated responses.

The run-out of remaining tailwinds from the COVID-19 national emergency may obscure a bit the progress that we're making when we get to the second half, but we see the results we've delivered here in Q2 as well as in the first quarter as evidence of positive trajectory on service revenue and margin.

Finally, interchange revenue, which resumed its seasonal pattern, as expected, with strength in Q1 followed by a more subdued performance in Q2. We think the HSA market HealthEquity now leads can grow by about 10% annually for years to come, thanks to steady account growth and faster asset growth as accounts mature, which in turn expands margin opportunity. Team Purple can extend its long record of outperformance by doing what it did well in this second quarter.

Before turning the call over, I would like to publicly thank Mr. Tyson Murdock for his unwavering service to HealthEquity's mission, vision, and values over the past 5.5 years. And in particular, for focusing his team on a strong finish and a smooth transition over these past few months.

Tyson is a class act, and you would do well to keep an eye out for the opportunity in whatever he chooses to do next. As Richard noted at the top of the call, Jim Lucania who will take over as CFO effective tomorrow, is with us today. Jim will be active on the conference circuit this fall, beginning tomorrow actually. And of course, will preside at HealthEquity's Investor Day in Utah in February, as Richard mentioned. Tyson?

All right, thank you, Jon, for those kind comments. All right. I'll highlight our second quarter GAAP and non-GAAP financial results. A reconciliation of GAAP measures to non-GAAP measures is found in today's press release.

Second quarter revenue increased 18% year-over-year. Service revenue was $105.7 million, up 3% year-over-year. Custodial revenue grew 51% to $98.9 million in the second quarter, and the annualized interest rate yield on HSA cash was 237 basis points. Interchange revenue grew 4% to $38.9 million.

Gross profit as a percentage of revenue was 62% in the second quarter of this year versus 57% in the year ago period. This is the highest gross margin quarter since we acquired WageWorks 4 years ago.

Net income for the second quarter was $10.6 million or $0.12 per share on a GAAP EPS basis. Our non-GAAP net income was $45.6 million for the second quarter, and non-GAAP net income per share was $0.53 per share compared to $0.33 per share last year. While higher interest rates increased custodial yields, and generated interest income, they also increase the rate of interest we pay on the remaining $287 million Term Loan A to a stated rate of 6.9%.

Adjusted EBITDA for the quarter was $88.1 million, and adjusted EBITDA as a percentage of revenue was 36%, a more than 360 basis point improvement over last year. For the first 6 months of fiscal '24, revenue was $488 million, up 18% compared to the first 6 months of last year.

GAAP net income was $14.7 million or $0.17 per diluted share, and non-GAAP net income was $88.4 million or $1.02 per diluted share, up 74%, compared to the same period last year. And adjusted EBITDA was $174.7 million, up 39% from the prior year, resulting in adjusted EBITDA as a percentage of revenue up 36% for the first half of this fiscal year.

Turning to the balance sheet. As of July 31, 2023, cash at quarter end was $290 million, boosted by a record $77 million of cash generated from operations in Q2 and $109 million year-to-date. The company had $874 million of debt outstanding net of issuance costs, and we continue to have an undrawn $1 billion line of credit available.

For fiscal '24, we're raising guidance, and now expect the following: Revenue in the range between $980 million and $990 million, GAAP net income to be in a range of $19 million to $24 million. And we expect non-GAAP net income to be between $171 million and $179 million, resulting in non-GAAP diluted net income between $1.97 and $2.06 per share based upon an estimated 87 million shares outstanding for the year.

We expect adjusted EBITDA to be between $338 million and $348 million. Our $5 million midpoint revenue increase is primarily based on revised expectations for the average yield on HSA cash to approximately 240 basis points for fiscal '24. As a reminder, we base interest rate assumptions embedded in guidance on an analysis of forward-looking market indicators such as the secured overnight financing rate, and mid-duration treasury forward curves and Fed funds futures.

These are, of course, subject to change. Our expectations are tempered somewhat by the anticipated impact of the end of the national emergency period that Jon referenced in his remarks on service revenue. Average crediting rates our HSA members receive on HSA cash remained flat sequentially and the crediting rates our HSA members received are determined in accordance with the formula described in our custodial agreements with them.

We continue to expect these rates will rise as overall interest rates remain elevated and have included in our guidance a 5 basis point increase by the end of fiscal '24. Our guidance also reflects the expectation of higher average interest rates on HealthEquity's variable rate debt versus last year, partially offset by the reduced amount of variable rate debt outstanding.

And then we assume their projected statutory non-GAAP income tax rate of approximately 25% and a diluted share count at 87 million, which now includes common share equivalents as we anticipate positive GAAP net income this year. As we have discussed, moving to positive GAAP net income impacts our GAAP tax rate strangely this year. Discrete tax items may also impact the calculated tax rate on a low level of pretax income. Based on our current full year guidance, we expect roughly a 50% GAAP tax rate for fiscal 2024.

As we have done in recent reporting periods, our full fiscal 2024 guidance includes a reconciliation of non-GAAP to the non-GAAP metrics provided in the -- to our 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 intangibles is being excluded from non-GAAP net income, the revenue generated from those acquired intangible assets is not excluded.

My time serving our members, our teammates and investors over the last 5.5 years has been a real pleasure. We made a lot of progress, and I'm confident the team will continue the course as I'm driven to my next opportunity. And with that, we know you have a number of questions. So let's go right to our operator for Q&A. Thank you.

(Operator Instructions) Today's first question comes from Greg Peters at Raymond James.

I guess before I begin with my question, Tyson, I'd also like to congratulate you on your service at HealthEquity, certainly helped the company through some challenging times. Jon, in your prepared remarks, you mentioned something about sustaining a 10% growth. And I was just curious about your perspective of the macro environment from a competitive standpoint.

You're seeing numbers from Devenir and others suggest that some are having some success, maybe as much success in growing share as you are, while others are not. Just an updated view on how the market looks to you today?

Well, I think if you sort of think about where the market is, you have 2 factors that ultimately drive revenue growth, which is the first thing that as investors we care about. The first is account growth and the second is asset growth. And account growth, in my view, will -- if I look at it on a multiyear basis, we'll kind of be in the high single digits, and asset growth will be in the teens.

And revenue growth is typically somewhere between the 2. I think -- and I don't really see any reason for much change in that view based if I'm trying to ask the question over multiple years. And then, look, our job is to outperform the market in terms of assets, accounts, et cetera, and then to do a better job, the best job we possibly can, and hopefully a better job than others at generating both revenue and profitability from doing so.

All right. My detail -- and my follow-up detailed question is on free cash flow. Nice improvement on a year-over-year basis, it looks like the gap between adjusted EBITDA and free cash flow is narrowing. Maybe you can just update us on how you're looking at free cash flow for the balance of this year and are there any headwinds that we should be thinking about with free cash flows you think out beyond this year?

Maybe Tyson, would you mind starting with regard to the sort of balance of this year question? Anything in particular that -- I think the -- gist of the question is, was there some jump forward or the like?

No. I mean, I think this is to be expected as the custodial revenue increases with the very high margin and cash generation capability, we know that it's going to accelerate that cash. And as you see, the positive GAAP net income come in, it's overcome now all the amortization from the WageWorks, and other deals that are in there. So the business is starting to per on that generation of custodial cash and I'd expect that to continue going forward.

Of course, the one -- there's other -- there's things in there like we're going to start to pay taxes. So, we got wires going off for taxes, you can see that in there. And other than that, I think the other things that are in there, like property, plant and equipment purchases and just what we spend on tech and things like that, there isn't huge changes in there that would cause other things to occur. So it's going to continue to move up.

And Greg, as far as use of cash, where -- first of all, it's worth noting that if we do nothing over the course of multiple years here, and it's not too many, the free cash flow is basically going to eliminate our leverage. And we're very comfortable with current leverage. And I don't want anyone to take my statement as suggesting otherwise.

But that's probably not what's going to happen, meaning we probably will want to look at using that cash and -- or we will want to look at using that cash as we have in recent quarters. And from my perspective, in terms of order of cash utilization, there's portfolio transactions that we like, because they are reliable ROI. And then we've paid down a little bit of our Term A.

I would expect that where portfolio transactions aren't available or where it makes sense. At some point, we'll continue to do that. And then it's worth noting that within the current envelope, we've committed to investing in organic innovation. And we're starting to see pieces of that come through. You will see more pieces of it come through.

And it's, I think, helpful when we get a question, as I'm sure we will later, about T&D expense and the like that we're able to do that within the envelope. We haven't ultimately while bringing T&D expense as a percentage of revenue down over time.

And our next question today comes from Stan Berenshteyn with Wells Fargo.

Thanks for taking my questions. On a personal, not yet, not yet, although I'd like to. But -- would like to say on a personal note. Tyson, it's been a pleasure working with you. Maybe a couple of questions. First 1 on your sales pipeline. Any changes in the RFP volumes you're seeing? Any changes in your win rates or perhaps what employers are looking for?

Yes. Probably the most notable thing we've seen, Stan, this year is -- I mean, let me back up and say, generally, the commentary I would give on account growth is that, on the one hand, and similar to what we said in the first quarter, on the one hand, you've got the sort of less tailwind from a macro perspective, new job creation and so forth. And then on the other hand, we are seeing higher new account onboarding.

And then more importantly, the sort of pipeline and start work for fiscal Q4 calendar January build. And the source of that build is -- so that's all providing a bit of an offset. And I think when I look at the pipeline, what's interesting this year is, for the first time since the pandemic, the enterprise pipeline has been very robust. And I'm not prone to like give answers without data. One answer that is given is okay.

People now have the space to make changes that they weren't willing to make. That's certainly possible. But in any event, it is worth noting that, I think the biggest thing I would note that's different is the volume of enterprise deals that we are seeing, and that are turning out not to be just price checks or whatever, we're able to win business away from competitors as well as greenfield business.

And then one more on custodial assets. Can you give an update on the current mix of assets that are in enhanced yields? And where do you expect that mix will be 12 months from now?

So we've given guidance for the -- guidance is maybe the wrong word. We've said that, see, I listen, I pay attention. Richard is giving me a face. This is what I get for being here. You -- so we said that we'll hit about 30% by the end of the year, and I think we'll end up doing a little better than that.

It is true that at this point, one of the limiting factors that we're working with is the timing of roll-off of our deposit contracts and the like that are also barriers as well as appropriate education of consumers. So I guess I would say that in general, the enhanced rates program is moving at or above the pace we have discussed. And we think that the end result of this is going to be both a higher, for lack of a better word, neutral rate as well as ultimately less cyclicality because of the features that we've been able to design into this product.

And so, I'm really excited about where we're headed with it. I'm excited to have Jim take a look at it, and see where he can add and improve, and we'll have more to say about it as we go in the next couple of quarters.

And our next question today comes from Glen Santangelo with Jefferies.

Just 2 quick ones for me. Jon, I was kind of curious if you can give us any update on the average duration of the portfolio? And if that's changing at all with this enhanced rates product, because I think as most of us are probably aware, I mean, and you are 3 years ago, today, the 10-year was sitting at 65, 70 basis points, right? So you're getting ready to do a replacement kind of coming up here in a few months. And I was kind of curious if you could help us in any way think about the waterfall. And then I just had a follow-up on margins?

Yes. I'm going to give you a lot of words that I'm not sure are going to answer the question you asked. Okay. So let me just. Let me comp.

All right.

In general, we have not made any change with regard to the -- fundamentally with regard to the approach we take to the duration of our cash portfolio. I think that's fundamentally what you're asking. That is to say with -- and by cash, in particular, I mean our deposit portfolio, right? We deploy the actual contracts that are deployed are 4 or 5-year contracts.

And when you kind of swizzle in the fact that there's variable rate cash and there's money above the minimums and whatnot, right? You're really talking about duration historically, and by duration here, I mean, liquidity-related duration that's around 3 years. Now, so I think the premise is right. There are a couple of things that I mean -- and I think generally, the premise that your question, I think, suggests that you have, Glen, which is that over the next couple of years here, there's a lot of cash that will be running out of deposit contracts and particularly to the extent -- well, even if it were placed in new deposit contracts, so particularly to the extent it's placed in enhanced rates, right, is going to produce a nice bump here and that will include all of the COVID year of cash. So you think about -- and that includes both the natural runoffs.

But also the kind of roughly 5-year single placement associated with the timing of the wage conversions in calendar 2020, I believe. I may have that wrong, '20 or '21 one of the 2. But -- so there is a lot of opportunity here. We think it was absolutely the right time to be looking at whether the deposit instruments were really serving our needs and those of our members. And I think we've made the right choice in pursuing this mechanism.

And look, the result is going to be under any reasonable economic scenario or any plausible economic scenario at the moment is going to be that it's not just that cyclically we're going to see high profits, it's that on an ongoing basis we're going to see higher profits from the custodial line and that seems good.

Right, I mean, just to you use your words, Jon, I mean, you said there's a bump coming and I just want to make sure I'm correct in thinking there is a bump coming, even if you don't want to size it today, because when we go back and we look at those -- those COVID sort of cash rates, I mean, it's pretty clear there is a big bump coming?

Yes. I mean, as you well know, Glen when -- I think people got a little ahead of their skis at the beginning of calendar '23. And maybe -- and so I want to be thoughtful about not creating an even bigger -- your skis. But, but I think -- but the premise is correct, and I think it will be sizable.

All right. And maybe Tyson, just one quick one on the margins. I mean the EBITDA it was up -- adjusted EBITDA was up 360 basis points year-over-year and, I know there were some member and balanced growth and the improvement in the custodial yields obviously, and some technology benefits. But I was wondering if you could just real quickly sort of unpack that to help us think about what's really driving that better EBITDA, when you think about those three contributors?

Yes. I mean, it is the custodial revenue obviously falling down to the bottom. We knew that would drive it, and like we've talked about, if you go back to history and way back and we did hit a 40% EBITDA margin in one of the quarters in the middle of the summer, like this one. And so, we're moving back towards that as that moves up, but I do think that we've been very thoughtful about, how we managed the controllable costs.

And when I say that, I mean, not something like stock-comp, which is -- which we benchmark just fine, with all of our peers. But it does get added back into EBITDA, what I'm talking about is what our executives work on every single day. And we're very thoughtful about how we build budgets and who we hire and how much we improve compensation and those type of things.

And so, I think that's just a matter of the seriousness with which the team it takes that and that's why we we're able to raise our EBITDA guidance by 5 along with the topline, normally you see as a percentage of topline raise. So it's just being thoughtful about those efficiencies. I do think that it's also true that there's efficiencies, the beginning that have been gained on the service cost line-item. And that's again, where a lot of the executives are working on that. And I think we've set ourselves up for longer-term success, there as well.

And it will start to show. And so I think those are some of the things that are sort of showing through on that. And it will continue to get the benefit of the enhanced rate program pushing down through there as well, like we've been talking about. So that will, that will continue for some time.

And our next question today comes from Sean Dodge with RBC Capital Markets.

Maybe just going back to the enhanced product. And just to further clarify how those work. I know, Jon, you said you placed cash in those for 5 years, but you've also said, before they're designed to produce more smoothness and yield over time. So does that mean, should we think about these being more I can variable-rate product, or is that smoothness coming more from the fact that these are layered in over the course of the year, not all happening in lumps around the January timeframe. And then so, as these roll, kind of on their 5-year latter it's happening more intra year that have been January and that's what smoothness is covering from maybe just a -- help quantify that?

The answer is that, there are really 3 sources of this and we thought quite a bit about this as we work-through these products. The first is the second point, you mentioned that is to say the fact that that money when you do cash. I'm sorry keep saying, when you do deposits like you strike the deal and you send all the money and that's it. Here, you do have the ability to layer money in, kind of, for lack, but from dollar cost averaging now.

And so that does really help and at some point, we're not going to be talking about if we have our way, we're not going to be talking about tremendous uncertainty on this topic, when we announce the December quarter and the like, and I'm sure you all look-forward to that, as we will. The second factor is that the variable cash that we need to maintain liquidity is built into the instrument.

So in the bank instruments, right. Yes, they have a min and a max, but fundamentally they still work, like, term deposits and so we have separate cash today about $500 million or about 4% of our -- 3.5% of our total HSA cash, that is in purely variable-rate instruments, and we need to have it there, because of that protects us against any liquidity issues.

And so, the liquidity is built into -- the contract. And so, that's very helpful in terms of eliminating situations where you have occurred in March of 2020, very rapid changes in government policy and the like, that produce big changes in and particularly downward in in variable rates. And then the third factor which I guess will get into a little bit more I'm sure this will be on the agenda when we get to Investor Day.

But is some stuff that is internal, I'll just say internal to the contracts that is just really designed to some extent to provide a little bit of trade-off between rate, and non-cyclicality. We really recognize that it's not in the interest of our investors, nor is it valuable in terms of managing the business, for people to start thinking about these dollars as anything other than what in the end, they really are, which is fees, right?

And, when we've been -- when we're fully exposed to deposit products as we have been, though we've done everything in our power within that world to try and minimize that cyclicality right. There still, particularly when you close to rebound, there's quite a bit of it and. So, that's the third factor and again we'll I'm sure go into details at some point.

But take all these together and it's not that there aren't going to be ups and downs, there are. Okay, but it should be the case A) that we're at a -- the more money that goes into these products, the higher the neutral rate will be. And second, the less variability there will be are the less variability there will be with short-term changes in interest rates.

Okay, and then you said, the goal is to transition 10% give or take of the deposits to these, it sounds like you're tracking at or slightly better than that. Is that still the way we should be thinking about that over the longer-term. Are there opportunities out there at some point to start to accelerate, how quickly you transition cash and the enhanced that?

Unless we tell you otherwise, that's the way to think about it.

Okay.

And our next question today comes from Scott Schoenhaus with KeyBanc.

So congrats Tyson and it was also a pleasure working with you. Good luck -- for your next adventure. So I just -- most of my questions have been asked, but I just wanted to drill on service fee side, how much of that was driven the growth driven by I think we talked last quarter about -- let me raise fees versus the underlying improvement in my commuter et cetera. If you could break out any differentiation that'd be great?

So if you look at it service fees. It's particularly if you take the -- if you look at it service fees, I believe grew slightly faster than accounts. So, then total accounts, and it's a little tricky, because most service fees come from CDBs, and the like. But I would say that the bigger issue here was just was volume-driven and we are starting to see some of the rate increases that we put out there and talked about in the first quarter, start to come through in actual collected revenues.

And the like, but I think you're going to see a little more of that, particularly as we get into the beginning of fiscal '25. As a critical factor, of course, we also hope that volumes are up as well, but I think for the moment, what you're seeing is a little more volume-driven on the topline.

Great, that's great color. And then just on the balance sheet, $290 million plus of cash. Anything changing in the M&A environment versus 90 days ago?

Thanks, Scott. We commented, 90 days ago that we felt, like-kind of, given the proximity to the deposit crisis on the bank side that deals weren't likely and that's why we went ahead and if you recall back at the end of April started to -- we start, we did a partial paydown on our Term A, we sort of just did the math and it made sense.

But I should say, Tyson, did the math, and then he showed it to me. He showed it to me and I said no, like 5 times, and he kept showing it to me and he was right. But I think that with a little bit of distance from that. It's we are seeing a little bit of thaw, you've seen some transactions announced primarily in areas where the HSA is a piece of the business, but not the whole of the business.

And those generally are transactions that we're going to do at this point, but so you've seen a few of those. I think also you know in truth, the fact that things like the move to enhance rates, the increased investments that we're making, and presumably others who want to be competitive will make too. All those factors raise barriers to staying in the market. And so, I do think that it's possible that over the next while.

You will see 1 or 2 of the larger players. I don't think the very top of the bracket, but in that area break free. And we're pleased to be in a position to be ready to do those transactions and the nice thing about them, as you know, is that from a shareholder perspective, we've done a number of these. We know we don't need any kind of banker multiple magic to make them work, it's we look at the IRR.

And if the IRR works, we can do it and from a cash-flow leverage perspective. These portfolio type transactions start cash flowing on day-1. And you're not having to muck around with synergies and all that we've dealt with in other transactions, but not in this type. So I guess. I would say that's just a long way to say.

I think it's incrementally a little bit better. But I think particularly on the smaller transactions. The like just plain old bank transfers that occur. Little less still less of those. The small banks got a pretty good scare. I think they are still pretty scared.

And our next question today comes from Allen Lutz with Bank of America.

I guess 1 for Tyson. As we look at the custodial revenue and I went back and looked at custodial revenue really since the IPO and it goes up, basically every quarter. Only in fiscal '21, did really ever dip, but I guess. I wanted to talk about the components of the about $4.5 million increased sequentially, in custodial revenue in the quarter. Can you just talk about what were some of the drivers of that? And then should we see some of those sequential drivers impact revenue going from 2Q to 3Q this year?

Yes. I guess we have some deposits that occur in the middle of the year, which are smaller, Allen. So we make adjustments there. And as we feed money into enhanced rates as well kind of operating. We got to make sure you operate between the minimum, the max of the deposits on the FDIC side. But we can start to continue to see dollars into enhanced rate program, you see that start to accelerate as well.

And so, as Jon said, we're a little ahead of schedule on our goals there too. So that's part of the -- story. We've also continue to do a little bit better on how we monetize client held funds against the rate environment that's currently available to us. And so, we're making a little bit of improvement there and I did credit we got a new.

We got a new treasurer in there, he is making improvements and looking for ways to squeeze more dimes and nickels this and clearly, he's done a good job. And so it's kind of all those things amalgamated together.

And surely one thing if you're doing a year-on-year comparison. This is what I'm doing Richard's bidding and I expect to be -- see. And I expect that to be noted and -- mostly if Richard tells me to do.

Looking for a complement?

Something. I'm just looking for acknowledgement that's all. Well occasional positive reinforcement. Is that in the last year, 2 things happened that I think, are you're not going to see this year. And they happened in tandem. 1 is obviously rates took off variable rates took off from zero. So, the variable component was in percentage terms was a big boost that we didn't see coming at the beginning of the year.

And we're I should say certainly wasn't there. And then second and tied to that, we began this effort that Tyson referenced about generating custodial income from the CDB side of the business. And that was a lot of work-over the course of a couple of years since the WageWorks transaction, because that's where most of that CDB. The CDB funds come from and yet, there wasn't a real hurry to started-off because marginal rates were roughly 0. And so you won't have that same ramp this year.

So if someone is doing a year-on-year comparison. I think the better way to do that is to look at you just you can look at where things are now, you can add whatever cash you think you can add to the current pile and take our rate guidance for what it is. And you'll have a pretty good view of where things are going to be for the rest of the year. The rate guidance obviously implies about 10 basis-points higher in the second-half and so the maths not that hard-to-do.

Very well done, Jon.

Thank you. Finally, now. I have now -- in front of me. I can dive now.

One quick 1. 1 quick last 1. So, Jon, you talked about new logo growth and expanded network partner footprint is kind of supporting the growth for HealthEquity and then you talked about a 10% market growth rate. I guess as you think about some of the wins, you're seeing this year new logo growth. If I'm a if I am a prospective customer, what is the impetus to change or to switch vendors this year, is there something different that's driving more customers to switch or is it just kind of more of the same?

I think and now we're getting into the realm of like speculation informed by data, which is the most dangerous kind, but I think there's two things that are happening. And I would invite Steve to comment on this as well. The first, is that, I do think it's probably fair to say that there are some HR departments that are coming out-of-the pandemic.

And in particular, coming out in a period where they've already now seeing one year of inflation and its impact on the wage side, but they didn't see it as much of an impact on the benefit side, until this year, and now they're seeing it. So there's a little more attention being paid benefits design and do I have the right vendor mix to optimize what I'm trying to do on the benefit side, and I think we're a great partner in that environment.

And then I think the second factor is, that it's becoming somewhat clear who's in this thing to win it and. Yes. I think there's a number of firms that are really there to do that is somewhat smaller than it was, but maybe Steve, you're right, so Steve spends more time in airplanes, than I do almost doing anything. So you are most qualified as I speak to what's going on out there.

If you go back to the history, right. We did that wage deal. Right. Before COVID and then COVID hit everyone and look, we it took us a while to get everything lined-up and integrated and getting the teams working together and regaining frankly trust from brokers and consultants and large employers and things like that that we could execute with the much bigger company going from 900 HealthEquity teammates to 3,500 teammates after the acquisition.

To really be able to know, and I think we've regained a lot of that trust back. And whether it's the trust of a HR professional that knows that the trend to make a big it's a big deal right to move 5,000, 10,000 or even 5 or under a 1,000. There are folks over that close you can on such reopened new and everything, they have to be pretty sure that you're going to the right solution.

And so, I mean I think the great thing about HealthEquity is that our services has always been a highly-regarded. We were able to do a lot of these integrations and things like that and now, I think if you really talk to the market talk to the consultants, large employers small size mid-size.

And of course, all of our health-plan partners they really believe that we're hitting our stride from a service perspective, which makes it a lot easier, to make those kind of changes when you don't need to worry about just system is not working and things like that. So, I think we're very well-positioned.

And then more macro Jon, already spoke to the fact that. When you're just trying to hire people and you're dealing with resignation and great transfer and all that other stuff. And now it's a little bit more of a rhythm to people's benefits, now is a good time to kind of say, alright. And to start looking at where we can really drive some deeper adoption health savings account like that -- and they know that we're in a proven leader in that space of really helping their workforce embrace health savings accounts.

And our next question today comes from George Hill with Deutsche Bank.

And Tyson, I'll echo the positive sentiments and great working with you. I guess, Jon, 2 quick ones from me and I'll try to keep it brief. First is, you talked about the enterprise pipeline being robust. I don't know if there's any way you can quantify that or to throw some numbers around it, and kind of what's the strategy to gain share as we go through the upcoming selling season. And then, I'll pause and come back on the second one?

Yes. I got out of the game of giving sales pipeline numbers, and I'm not going to get back into it. That's 2 in 1 day. But let me say, from a strategy perspective, briefly. And this isn't rocket science. We are the market leader across this bundle. And we are -- we're good people and we have, when if you are -- we're not going to like throw up NPS numbers.

Like, but if you -- if you were to look at that data, you will see that where -- I think others have been a little more challenged over the last year or 2, particularly this last year, the team just busted it's butt, and delivered a -- and I am not using this word likely a remarkable open enrollment season. And if you think about the way enterprise works a lot of those enterprise deals start during -- they kind of start the sales cycle starts at the end of the prior year.

And people can do things, like they can call your call center in January, and see how long the wait is. And see whether people are hurried or not, and all those kind of things. And so, those things matter. And then lastly, George, I'll say on -- from a strategy perspective. We are -- and we are showing our clients where we are spending on some cashing my chips here, on the tech side. And people are seeing what we're doing.

It's not like, they're not as you know, we do not do press releases for features or clients, that's not we do right. But folks who are looking at our roadmap or looking what comes out every month or so, we're looking and you'll see some of this over the course of next 6 months. But, there's really neat and interesting stuff going on and what it basically just conveys is that again back to an earlier comment that.

We were at a place of -- that relative to some of our competitors and certainly relative to other segments, we are very fortunate to be in a place where we can invest at a time, where investing in the infrastructure, in the technology, in feature function, in product, actually matters, versus a period where there's not that much new happening.

And so, I think our -- the enterprise that really gets to pay attention to that, whereas the small groups kind of don't, they are seeing that. And I think you're going to see it to over the course of the next year or so.

Okay, that's helpful. And I think, I know you're going to give me an answer to the pipeline questions. So I have a follow-up which I also, I'm not sure that you'll give me an answer to. Given that we've talked about kind of the average -- well I know that the company historically has not -- you guys don't think of yourself as in the business of prognosticating rates. However, people in my business or in the business of prognosticating rates. And given where we are in the rate cycle, do you guys think about proactively trying to extend duration, because I imagine a lot of people in my business, if we're looking out 3 years, we probably think the next rate moves down versus up. So just kind of like, like is there anything that you guys are seeing in the rate environment that kind of makes you want to change the way that you guys think about how you kind of put that custodial cash to work and duration and timing?

Yes. So I I'm going to give you an answer this only slightly different, than I've given you this question before, but the slight is probably relevant. Let me first say the answer, we generally give is that from the perspective of the instruments and the duration of the instruments in which we have "invested" in the HSA cash flow. We've not exactly as you say, we've not been prognosticators and we've tried to generally, whole aggregate duration for liquidity in that kind of 3, 4 year range.

I will say one of the benefits of the enhanced rates product, one of the features that allows us to have some trade-off around this, is that we can meet our liquidity needs, while the instruments in the portfolio are somewhat longer-term instruments. And so, while that wasn't particularly designed with a moment like this one in mind, a practical effect of it is to the extent that we're placing funds, whether it's at the end of the last cycle or in this cycle, and towards the end of this cycle -- by cycle, I mean year and so forth.

We're going to be locking in in that context of higher yields on those placements for an extended period of time. And so I do -- again, I want to be thoughtful and cautious in saying that. First of all, when managing the company and expenses we think about neutral rates because like spending into -- and honestly, we're not actually at neutral yet if you think about it.

But I do think there is a practical effect of the way we're doing this is, is going to produce more benefit from this cycle than we've seen from prior cycles, where then we would see, if we were just using our same deposit instruments that we have in the past.

And our next question today comes from Mark Marcon with Baird.

Mr. Marcon.

We're really getting into the off tangent aren't we?

We are.

Tyson. It's been a pleasure working with you. In terms of the -- in terms of serious questions just on the yield moving up so much on the cash. Was that partially just due to the enhanced yield product is becoming a bigger portion of the overall deal, because obviously fed funds doesn't fully explain it. So I just wanted to 100% clarify that?

Yes, in addition. I would say during this period to the extent we had any bank placements and they would have been small. I think we've talked about before that the bank placement markets is being wayward, right now, but I think…

Great. And then, and then if we take a look at investments. I mean 23% growth in terms of the investments there, obviously there has been an impact with regards to the overall market, but what are you seeing just in terms of the behavior of the holders. Are they, are they starting to chase additional yield even through like intermediate bond products, or anything along that line. Are you seeing any sort of movement from that perspective and how should we think about that?

Yes, thank you for asking that question Mark. We -- our portfolio offering does include things like ultra-short, bond funds that kind of behave in the same manner as money market. But I think don't fuzz the distinction between insured by the federal government and non-insured by the federal government, and so. As sometimes you see with some of our other folks in the marketplace might do. I don't think they intend to, but it's the practical effect.

So, and those funds have been quite popular. So, I do think there is an element of this that is investor -- that is members saying you know what, I'd like to get more yield and I can get on cash. I know, I'm not going to do anything with it. Let me put it in at least today, tomorrow, I'm willing to give up the clarity of I can swipe my card or whatever. And I'll put it in some of these products.

I think there's some of that. I also think that there every day there's an article in the paper that you can decide what the motivation is, but it's like yeah, those 5% CD yields are great but -- it still doesn't beat the stock market over the long-term. And so, there's some of that too, but I think it's probably fair to say that there is an element. And that's a win from our perspective in that well sure on that incremental dollar.

We might earn more if it were sitting in cash that's a customer that's going to be sticky, we're giving them the product they want. We try to guide them to exactly the product that they are asking for. If they're getting capital A advice from us, that's part of the discussion. I mean it's. I just think at the end-of-the day.

And it, while our the rates we pay on cash are determined from a formula, nonetheless, it's probably the availability of those products and parts that has allowed, not just us, but the broader industry, to kind of keep a lid on custodial expense. And so, I guess I sort of think that's a win. That's how I think about it.

Thanks Mark.

Thank you, Mark.

Your next question today comes from David Larsen at BTIG.

And Tyson was great working with you, I thought you did a great job, guiding the company through a very-very tough cycle. Can you maybe just talk about either Jon or Tyson, the revenue delta on interchange 1Q versus 2Q. So, obviously, down about 13% and is there any more clarity around like the COBRA impact. And if you can describe what exactly that was would be very helpful?

Tyson, you want to hit part A of that.

Yes, on the interchange David. I mean that's just the normal seasonality. So, we've got people, essentially spending as they loaded up the HSA accounts in the first part of the year. They're going to spend more. And then as we move into the summer months, they're going to spend less. They're not. They're not home spending actually. And so we always get that seasonality through.

So you'll see a Q1 high point, you'll see a Q2 Q3 softer point, and then as we move into Q4, you've got use it or lose it, and you've gotten kind of the remaining funds on those on those CDB accounts that get used up, and so you see a stronger Q4. And that's why you see that. And so, that's seasonality looks a little funny in history. So it is hard to decipher that, because the COVID effect over the quarters are in history.

Now it doesn't look is, it doesn't look as smooth just that seasonality explained that's kind of one thing. And then, Jon, you're going to hit the COBRA side of it unless, David has a follow-up.

Go for it you are on a role.

Yes, and on the COBRA side of it, that's just, again, we've got we've mentioned in the script a little bit of the legislative effect of that. And so, with regards to FSA and COBRA, this has been -- that's been tough to forecast, all the way through, having the national emergency legislation out there.

And with regards to COBRA, just the fact that people don't have the optionality to go into COBRA multiyear-after, after exiting a job, that changes how we essentially drive revenue of the different communications that we make to them. And also just the number of people that sign-up, given the -- I think given the broader strength in the economy that maybe wasn't expected. So those are kind of the things that kind of push -- those things around.

Okay, great. And then. I think what I'm hearing also is that in terms of like the risk of a recession or the risk of a slowdown next year, you're not seeing any of that in terms of demand. In fact, it's kind of the exact opposite. There's lots of demand you're signing up a bunch of clients, is that right?

I mean I don't know that our clients in the human resources department are experts at predicting recessions. But I think people are. I think it's probably fair to say that. What's happening out there is that people are anticipating tighter conditions, whether that's a recession or not. I don't know, but the effect of anticipating tighter conditions is, there is that they're attentive to plan design and win-wins and things like that that we talked about earlier in the call.

So, but in terms of when. I look at the account numbers that change as a result of -- that are a function just of new job ads and the like. I mean, our data are moving in tandem with the national data at this point. So, I think there's nothing that would surprise you there.

Okay and then. I think you basically renegotiate your contracts every 3 years with your clients, which. I think would imply that the yields of that drive custodial revenue should continue to increase through next year right?

Yes. I refer back to the answer on that one to. I think it was Glen that asked a similar question. And just but just to say. Our duration is 3, but our bigger contracts, the deposit contracts themselves, may be 4 or 5 years. So you're going to see quite a few of these come through over the next couple of years. And also, during obviously the last few years have been quite a bit growth. So you if you look at this, you need to go back to your reference here versus dividing today by that number.

Okay, and when you -- when you say you will see quite a few of these in a favorable manner. I think is what you were saying right?

Yes. Yes.

Okay and then just lastly from me, your service gross margin. Obviously, showed some pretty good improvement in got as high as like. I think 38% in 2Q of '22, how high can your service gross margin trend to?

We've talked about this in the past. I don't I'm not able to make like long-run predictions, what I will say is, we're targeting the total margin. And particularly as we reduce the cyclicality of the other components. I think that makes a ton of sense. So I but -- I do think we have some room to grow from here. I mean. We ought to be able over-time to get this number back into the 30s, it may take us a little while, but the drivers of that are going to be, first of all, particularly growth in the CDB businesses, that are profitable.

And then secondly. The underlying HSA account growth and then third is going to be service tech. Where we can bring cost-down and we've delivered a little bit of that in this quarter and a little bit last quarter and heck we do a little light each quarter and the end of this lot of software business. I don't know I'm just kidding. That won't be true, but it is an opportunity.

Thanks, David.

And our next question comes from Alexander Draper from Guggenheim.

Not a lot left to ask. First, I'll just say. Well, I'll say, Tyson, it's been a pleasure working with you, hopefully we will get to cross paths at some point in the future. I guess the first question, if I just do the simple math of looking at the cash per account. It's down the types that I know that's just a 1 day comparison last quarter to this quarter. Just trying to think, you have much more visibility. This sort of ties to what you're saying, Jon, about the investments. Is there any notable change in behavior you're seeing, now versus maybe the past couple of years about the desire for people to pay themselves back, versus put the money and not reimburse themselves that would be the first question?

Now I have to ask, how many they're going to be because that after I'm just Greg, Greg is already off the line to hear all these like 8 partners. Not getting them, but here goes, look. I think first of all, it is worth noting that if you look at total assets for the quarter. This was actually a record growth period ex Q4's. I mean, you're talking about close to $1 billion in asset growth, over the course of a single quarter.

And that's really good. Also, if I break it down, and I think that the short answer here is going to be that. I don't think there has been very much difference other than the -- as we talked about it in earlier question. The increased interest in investment, no pun intended. Because if you look at Q2 contributions they are up year-over-year, exactly as you would expect. And it's just that the transfers from cash to investments, were way up.

And I think that just reflects -- it ultimately, reflects a better market backdrop. I mean, if I look at the same-period a year-ago. The S&P was off 13%. And during this period, it was plus about the same number a little bit more. And so, the better market backdrop and all that kind of stuff, but the underlying contribution behavior which is, I think really the thing you would care about was kind of about the same. Spend was seasonally pretty much what we expected. So, I don't think it's any fundamental change in spend behavior.

Okay, great. And then Steve hasn't gotten bored and dropped off, maybe a quick one for him, you commented on the environment around sales but CVRR man on-the-ground in DC, anything coming out, you're going to come out of DC, whether it's regarding Medicare, potential bigger step-ups and potential ability for people to invest or save in HSA anything new out of DC or is that really nothing going on there right now?

Thanks. And thanks, Andy. I think on this very day, there's nothing going on, in DC. But they're coming back. We continue to have some fantastic discussions. And I think, what kind of is different is that now, these are more bipartisan. And we're just kind of focusing on what do Americans need and whether it's loosening up a little bit on some of the qualifying attributes around the planning.

You've been around long enough, and thank you for your support over the years to remember that, there was lot of lack of clarity around things like preventative care, right? And that was, that was actually clarified under the Trump administration that allowed people to start paying for more medications, first dollar, and things like that and still have a high level plan.

That helps, and so that was not only to help that they introduced it, but then the Biden administration has been very supportive of those and they haven't changed and has also. So now when you look at a -- especially the large employers and then plans are offered by health plans. And you look at their benefit design, they are covering things like high blood pressure meds, and diabetic meds and stuff like that, as allowed by regulation.

So, I think that has actually cloud a little bit of the ground that we're trying to do, which say all right. We all agree every what American needs, what we would refer choosing instead of account, one that you can work with any plan, obviously with the plan we know that is the HSA, but is there are there other mechanisms to try and do that. And so, look I just, I am encouraged by the bipartisan nature of the discussions.

And despite everything that everyone sees when they turn on there, given news station, and how they think it's so torn apart. I haven't seen that, when I talk to Democrats or Republicans in Congress. And so, we are hopeful that we'll continue to see some, what we refer to as HSA or other type of account expansion, allowing just more Americans to have the benefits of one of these portable personally on investable accounts and what kind of plan and they are having so.

So that's what we've been focused on. It's just saying, how can, we expand that, but yes. I mean thanks for the question, I believe we continuing to make progress, and we're hopeful that certainly before the next presidential election, there will be some bills -- introduced that continue to expand the benefit.

So, we will make sure that legislators make the decisions and may started -- they started to disseminate that information out. And we will pass it along, but it's just constant education again. Thanks, Alexander. Thanks for your musical talent over the years to I always appreciate it -- your musical talent.

Ladies and gentlemen, this concludes the question-and-answer session, I'd like to turn the conference back over to Jon Kessler for closing remarks.

So appreciate everyone. And the kind comments for Tyson. For all he takes our teasing really well, always has and is going to be genuinely missed within the organization. But like I think this is not going to be the last time most of you on this call will see Mr. Murdock or hear Mr. Murdock, and certainly will not be last time I hear or see him.

And we'll see how this Lucania guy does you know. But, but one way to find out is to book your flights now, for February 22nd, 2024 this is big time, this is all like -- I mean, we're talking about broadway quality, type stuff. Actually. I have no idea. But I do know that --

Jon can I?

Yes.

I want to interject one thing on that. So, look, we think we'll have a good winter, and. We would love to not only guide you through our business, but maybe do some mountain guiding. And maybe we can bring Tyson back to help us be one of the guys.

Absolutely. All right.

I failed to thanks Tyson as well. Tyson, thank you. You've been a wonderful teammate and thank you for everything you done for HealthEquity.

Thanks everybody. I really appreciate it. Thank you.

All right that's it. We'll see you all in December and some of you before that and then of course in February.

Thank you.

Bye.

Thanks.

Thanks everybody. This concludes today's conference call. Thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.