Healthequity Inc (HQY) 2020 Q2 法說會逐字稿

Welcome to HealthEquity's Second Quarter of Fiscal 2020 Earnings Call.

Please note that this event is being recorded.

Go ahead, Mr. Putnam.

Thank you, Carmen.

Good afternoon, everyone.

As Carmen mentioned, this is our HealthEquity second quarter earnings conference call for our fiscal year 2020.

By way of introduction, we have Jon Kessler, President and CEO; Steve Neeleman, HealthEquity's Founder and Vice Chair; Ted Bloomberg, Executive Vice President and COO; and Darcy Mott, our Executive Vice President and CFO.

I would like to remind those that are listening that there is a copy of today's earnings release and accompanying financial information posted on our Investor Relations website, which is ir.healthequity.com.

We also claim the safe harbor concerning the forward-looking statements included in today's earnings release and that will be made during this conference call including predictions, expectations, estimates or other information that might be considered forward-looking.

Throughout today's discussion, we will present some important factors relating to our business, which could affect those forward-looking statements.

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

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

We encourage you to review the discussion of these factors and other risks that may affect our future results or the market price of our stock and that are detailed in our annual report on Form 10-K with the SEC filed in March 2019 along with any other subsequent periodic or current reports filed with the SEC.

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

We also want to remind those who are on our call today and during the Q&A that we ask for one question at a time, and Jon has asked you to make sure that it is a good one.

With that, I'll turn the call over to Mr. Jon Kessler.

If you ask them, they won't do it, but if I ask them -- that's part of the idea.

Well, it hasn't work so far.

Let's try.

Thank you, Richard, and thank you, everyone, for joining HealthEquity's Second Quarter Fiscal 2020 Earnings Call.

And with a special deep Purple welcome, hope those guys don't sue us, to analyst and shareholders of WageWorks which, as all of you all know, I'm sure we acquired on Friday.

On today's call, I will speak to Q2 results and our market position with the WageWorks acquisition now complete.

Ted Bloomberg, our COO, will discuss integration.

And Darcy Mott will detail these results and update guidance.

And then Steve will join us for Q&A.

We do have quite a bit to cover, and we'll do our best to do it quickly so that there are time for question -- there is time for questions.

During Q2, which did not include any impact from WageWorks, the team delivered record performance against the 4 key metrics that have driven our business and once again outperformed on year-over-year measures of profitability and custodial asset growth atop robust revenue and HSA member growth.

Revenues of $86.6 million were up 22% year-over-year.

Adjusted EBITDA of $40.6 million rose, an even larger 28% year-over-year.

HSA members at July 31 reached 4.2 million, up 16% year-over-year.

Active HSA members climbed 13% to 3.3 million.

And custodial assets reached $8.5 billion, growing at 21% year-over-year, which is more.

Progress was evident in members learning to use HSAs for long-term saving, invested assets grew 38% and the number of HSA members investing was up 31% compared to a year ago.

Underlying these key metrics, the team achieved several important milestones during the quarter.

For the first time in HealthEquity's history, custodial fees accounted for more than half of total revenue, which is reducing our dependence on service fees paid by our clients.

Also, for the first time, gross profits exceeded 2/3 of total revenue with gross profit margins of 67%, that's 2/3, expanding by more than 190 basis points year-over-year.

Adjusted EBITDA margins expanded by more than 200 basis points year-over-year to 47%, another record even after expenses made for larger platform investments as we discussed on our Q1 and, prior to that, Q4 calls.

Turning to sales.

The team opened up 126,000 new HSAs in the quarter, up 8% from last year's Q2 production.

And custodial assets grew by $195 million.

That's 15% more than the year-ago period, and it's despite essentially flat underlying equity markets during the quarter.

These were really tough comps, and the team beat them.

We attribute this outperformance really to 3 factors.

The first is the rollout of upgraded HSA complementary offerings that employers want to buy from their HSA partner.

The second is expansion of HealthEquity's distribution footprint as direct-to-employer selling expanded and our retirement plan partnerships really came online.

And the third is the resilience of the underlying HSA market as trends driving the long-term shift to HSA style health plans and greater use of HSAs remain in place.

Q2 also saw some notable regulatory developments that we expect to spur future growth.

The IRS clarified and expanded the scope of HSA-qualified plans to include plan designs with more coverage for chronic conditions.

And bipartisan legislation introduced in the House would extend the benefits of HSAs to all Medicare recipients which would significantly reduce out-of-pocket health care cost for seniors and especially those in traditional Medicare.

So that seems like a good thing.

In a way, Q2 previewed what we intend to achieve with the WageWorks acquisition which is a more complete offering, delivered across a wider distribution footprint, leading to outperformance over and above already strong HSA market growth driven by long-term secular trends.

That's a long equation, but it's working.

We call it the new HealthEquity.

And with WageWorks acquisition closing last Friday, today, as it turns out, is its second full day on the job.

The new team, Purple, according to Devenir's just published midyear market report, begins as the #1 HSA administrator by accounts and #2 by assets.

We intend to build on our lead while bringing our culture of remarkable service to our full product and to everything we do.

We introduced Ted Bloomberg to investors on an earnings call exactly 1 year ago, and nothing has been the same since.

But it's been a good thing.

Ted has increased -- just keeping him back in here.

Ted has increased the strength, the cohesion, the focus and the pace of our operating leadership.

He has delivered 4 strong quarters and become a champion of the Purple culture.

Ted is now at the head of the WageWorks integration.

And thanks to great preparation during diligence, a speedy close process, strong preclose work by teammates across both legacy companies and, most importantly, through alignment, we are off and running.

Ted?

Thanks, Jon.

I wasn't sure where you're going with that for a minute.

It's been great working with many talented HealthEquity team members in my rookie year.

And now over the past several weeks, I've had the pleasure of meeting many of the talented WageWorks team members that will join us in building the preferred HSA and consumer directed benefits partner for employers, benefits consultants and health and retirement plan providers.

We are investing $80 million to $100 million over the next 24 to 36 months to combine these 2 companies in a way that suits our clients, our partners, our members, our teammates and our shareholders and, most importantly, to bring Purple to everything we do.

During the integration period, we will report regularly to all of you on progress towards specific integration commitments we have made to customers, partners and to the markets.

First, specific customer and partner commitments.

We will serve all of our 12 million members with U.S.-based benefits experts available every hour of every day.

We will make it easier to do business with us for our approximately 115,000 employer clients by consolidating to a unified technology platform.

We will continue to invest in securing member data, maintaining strong privacy protections and continuing to prioritize data security.

We will engage families and educate them on how to optimize their benefits by spending less today and saving more tomorrow.

And we will deliver value, driving down costs by offering bundled solutions and making our services easier to administer.

Secondly, our specific financial commitments.

We will deliver at least $50 million in run rate synergies, including both revenue and cost efficiencies, that will convert to free cash flow efficiently to reduce our leverage.

And we will sell our complete solution to clients of all sizes directly and hand-in-hand with partners to continue to outperform the HSA market growth and extend our market share lead.

We will report quarterly on key integration metrics, including HSA members and assets, new HSA and asset growth and active-in-investing HSA members.

Total members, including both HSA and participants in FSA, HRA, COBRA, Commuter and other consumer directed benefits.

We will break down these total members by account type on an annual basis.

We will also report on run rate synergies achieved, including both revenue and cost efficiencies, against our 50 million objective.

And we will also report on onetime integration spend against the $80 million to $100 million we expect to invest.

We will also provide insight from the marketplace on progress towards achieving the strategic sales aims that motivated us to embark on this effort.

Some of these updates will be qualitative or anecdotal as the integration of our sales systems and teams may blur the origins of organic growth as we go forward and as we consider streamlining certain operations.

Nevertheless, we will not lose sight of your expectation that this integration will be a significant source of future growth.

While we have just completed our second business day as a combined company, I can report that the new HealthEquity has already taken a number of steps forward.

As Jon mentioned, finance and legal executed this closing in just over 60 days, well ahead of schedule.

During that time, our integration teams completed plans for over a dozen work streams ranging from platform consolidation to cultural integration, to our go-to-market strategy.

We have identified immediate opportunities for revenue and cost efficiency that have either already been implemented or soon will be, giving us a head start on our synergy commitments.

On our first day as a combined entity, our relationship executives personally reached out to over 2,000 clients sharing our integration message.

And over the next 60 days, each member of the new HealthEquity executive leadership team will complete a top-to-bottom assessment of his or her organization aligning leaders, teams and resources to achieve the customer, financial and strategic goals I described.

For the rest of this year's sales season, we will take a buddy selling approach.

Our first joint sales call began an hour after closing that was announced on Friday with Jon in attendance.

And finally, we have begun to infuse Purple into our service experience with our first joint service huddle this morning and the implementation of a bipartisan service escalation team to ensure our partners and clients are well taken care of throughout the transition.

One of the many things that will not happen overnight, however, is a brand transition.

We don't consider Purple just a coat of paint.

We believe that the real integration progress that our clients, partners and team members can see and feel should proceed changes to colors and logos.

We are off to a good start, realistic about the challenges but optimistic about the opportunities ahead.

I look forward to reporting our progress to you in the quarters to come.

And I will now turn the call over to Darcy to detail operating results and revised guidance.

Thanks, Ted.

I will discuss HealthEquity's operating results for our second quarter ended July 31 on both a GAAP and a non-GAAP basis.

A reconciliation of all non-GAAP results and guidance that we discuss herein to their nearest GAAP measurement and the definitions of all reconciling items in all non-GAAP measures is provided in the press release that was published earlier today.

Revenue for the second quarter grew 22% year-over-year to $86.6 million.

Breaking down the revenue into our 3 categories, we continue to see growth in each of the service, custodial and interchange revenue during the quarter.

Service revenue grew 5% year-over-year to $26.3 million in the second quarter.

Consistent with the strategy we have outlined over the last 5 years, service revenue as a percentage of total revenue declined to 30% in the quarter, down from 35% of total revenue that are represented in the second quarter last year as the custodial revenue stream has become more predominant.

Service revenue growth was attributable to a 17% year-over-year increase in average HSAs during the quarter, partially offset by a 10% decrease in service revenue per average HSA.

Remember, HSA service fees are paid primarily by employers on behalf of their employees.

And so by bringing these down over time, we deliver more value and help our network partners deliver more value to their customers.

It's working, and we expect it to continue.

As we indicated last quarter, we expect the decrease in service revenue per average HSA to be towards the high end of our historical 5% to 10% guidance for fiscal 2020.

Custodial revenue was $43.6 million in the second quarter, representing an increase of 42% year-over-year.

The driving factors of this growth were a 21% growth in average custodial assets and a higher annualized interest rate yield on custodial cash assets of 2.54% during the quarter, up 20% over the prior year.

Custodial revenue in the quarter accounted for 50% of total revenue.

Interchange revenue grew 8% in the second quarter to $16.7 million compared to $15.4 million in the second quarter last year.

Interchange revenue benefited from the 17% year-over-year increase in average HSAs in the quarter compared to the second quarter last year, offset by lower average spend of $7 -- 7% per HSA member.

Gross profit for the second quarter was $58.4 million compared to $46.6 million in the prior year, increasing the gross margin level to 67.5% in the quarter from 65.5% in the second quarter last year.

The higher gross margin was the result of increasing revenue mix to the custodial revenue.

Operating expenses were $33.6 million or 39% of revenue compared to $25 million or 35% of revenue in the second quarter last year as we started to incur integration-related costs and as we increased our investment in the previously discussed strategic initiatives.

We expect this trend to continue during the second half of fiscal 2020 as we ramp up the integration activities Ted just outlined and as we continue to work on our strategic initiatives.

Income from operations was $24.9 million in the second quarter, an increase of 15% year-over-year and generated an income from operations margin of 29% during the quarter.

We generated net income of $19.4 million for the second quarter of fiscal 2020 compared to $22.5 million in the prior year.

The decrease primarily was due to the integration-related costs and a higher effective tax rate this year compared to last year.

Our GAAP diluted EPS for the second quarter of fiscal 2020 was $0.30 per share compared to $0.36 per share in the prior year.

Due to the significance and the change from historical reporting of certain items related to the recently completed acquisition of WageWorks, we have expanded the reconciling items in our GAAP to non-GAAP reconciliations.

We refer you to the definitions of such reconciling items in our press release issued earlier today.

Our non-GAAP net income and net income per share for the second quarter of fiscal 2020 were $29.4 million and $0.45 per share.

Our non-GAAP adjusted EBITDA for the quarter increased 28% to $40.6 million compared to $31.8 million in the prior year.

Adjusted EBITDA margin in the quarter was 47%, the highest quarterly adjusted EBITDA margin in our history.

For the first 6 months of fiscal 2020, revenue was $173.7 million, up 23% compared to the first 6 months of last year.

GAAP net income was $61.2 million or $0.94 per diluted share.

Non-GAAP net income was $57.6 million or $0.89 per diluted share.

And adjusted EBITDA was $79.6 million, up 30% from the prior year.

Turning to the balance sheet.

As of July 31, 2019, we had $815 million of cash and cash equivalents with no outstanding debt.

This includes net proceeds of approximately $460 million from the common stock offering we executed in July.

Subsequent to July 31, we issued $1.25 billion of debt to help fund the acquisition of WageWorks which was funded and closed on August 30.

Turning to guidance for fiscal year 2020.

As we think about guidance for the remainder of this fiscal year, we recognize that we have more forecast and experience and, therefore, greater confidence in our visibility to the preintegrated HealthEquity business versus the component added with the acquisition of WageWorks.

We expect this to change over time.

Today, we are providing revised guidance for the stand-alone HealthEquity business and estimates of revenue and adjusted EBITDA margin for the incremental WageWorks component for the remainder of our fiscal year.

Based on where we ended the first half of fiscal 2020, we are raising HealthEquity revenue guidance for fiscal 2020, excluding the WageWorks contribution, to a range of between $341 million and $347 million.

We expect HealthEquity non-GAAP net income, excluding the WageWorks contribution, to be between $76 million and $80 million, reflecting the addition of interest expense for our newly issued debt and the non-GAAP definitional changes mentioned above.

This results in non-GAAP diluted net income per share between $1.10 and $1.16 per share.

We are raising guidance on HealthEquity's adjusted EBITDA, excluding the WageWorks contribution, to between $138 million and $142 million for fiscal 2020.

Please see the reconciliation of our non-GAAP measures provided in the earnings release to note that guidance on our non-GAAP net income and per-share calculations starts with GAAP net income which reflects interest expense and acquired intangible amortization associated with the WageWorks acquisition without including the WageWorks operating results.

These estimates do not include potential synergies.

Our non-GAAP diluted net income per share estimate is based on an estimated diluted weighted average shares outstanding of approximately 69 million shares for the year.

In other words, it includes the impact of the new shares issued as part of our July equity offering.

Before turning to the contribution from WageWorks, I would like to highlight 4 items reflected in the HealthEquity stand-alone guidance.

First, we expect to sustain our year-to-date interest rate yield on custodial cash assets of approximately 2.5% for the full year of fiscal 2020.

We will provide additional guidance on the expected custodial revenue to be generated from the WageWorks HSA assets as we diligently pursue efforts to move such assets onto our custodial bank partner network and platform.

Second, we remind you that we have borrowed $1.25 billion as of the closing date of the acquisition with a current variable interest rate of 30-day LIBOR plus 2%, which will be included in our income statement beginning in September, along with a 5-year amortization of deferred financing costs of approximately $27 million.

Third, our full year guidance includes a detailed reconciliation of GAAP and non-GAAP metrics.

We encourage you to review the detailed list of estimated reconciling items included in the earnings release distributed earlier today and note that there are some new items that had been added as a result of the WageWorks acquisition.

However, consistent with our prior practice, such estimates do not include a forecast for stock option exercises for the remainder of the fiscal year.

Fourth, we assumed a statutory income tax rate of approximately 24%.

We expect the WageWorks acquisition to contribute revenue in the range of $170 million to $175 million for the remaining 5 months of our fiscal year.

We expect revenue contributed from the WageWorks acquisition to generate an approximate 15% adjusted EBITDA margin for the remaining 5 months of our fiscal year.

This 5-month period includes the cost-intensive benefits enrollment period.

This is a baseline for the business as we have received it.

Therefore, it excludes any revenue and cost synergies that we may realize this fiscal year.

As Ted mentioned, we are already working to reduce costs and realize revenue synergies from combined operations.

With more clarity on timing, we will provide an update on these activities when we report our third quarter in December.

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

Thank you.

Before Carmen takes us to Q&A, I want to take a moment to thank my remarkable teammates in the new HealthEquity for their work in completing the acquisition, for the fast start and integration and mostly for their enthusiastic embrace, despite the uncertainties of any situation like this, of our vision going forward, all of that while delivering a record Q2.

In that same vein, all of us at HealthEquity truly appreciate the support of shareholders for that vision.

Please note that we understand our accountability for seeing that your trust in us is ultimately well rewarded.

With that, Carmen, we'll go ahead and take questions.

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

On Wage, it looks like the first 6 months of the year saw a little bit of a revenue decline on a year-over-year basis.

I'm just wondering how we should think about what the back-half guide implied in terms of those?

And then what kind of baseline are you targeting for that as we're moving forward?

Okay.

Thanks, Anne, appreciate the question.

So as you say, if looking at the first 6 months that WageWorks reported, revenues were down about 7% year-over-year.

And as WageWorks said, that is primarily due to renewal issues -- lack of renewals I suppose -- primarily in FSA and COBRA and within the book of business that WageWorks manages which was previously associated with ADP before ADP exited this consumer directed benefits business.

Our view, what our guidance reflects is that in the second half that there'll be a little bit more of a pronounced decline.

And the source of that -- and you can do the math to get there.

And the source of that is really threefold.

The first is that -- well, the first is what I mentioned, that is to say the 7% climate that the company saw in the first half.

Second is, during the first half, there was still runout of that business.

And that runout produced revenue, but it's pretty much kind of played out now.

And so the company won't see that.

And then lastly, of course, WageWorks, unlike HealthEquity, the HSA business is very much tied to third-party custodians.

And the company's revenue from those products on the custodial side is very much tied to, in a very immediate way, changes in the overnight fed funds rate.

And as you know, one of the things about our model is to provide a lot more stability than that.

And so -- but it will -- as Darcy said, the guidance does reflect synergies, timing, et cetera, so on a stand-alone basis, Wage would have seen some revenue loss from the rate cut that occurred, I believe, in July and presumably from any further rate cuts that might happen this year that many expects.

So those are the 3 factors that led us to a forecast that assumes a little bit more pronounced decline than the company saw in the first half.

That's very helpful.

And then I guess maybe just a follow-up to that.

As we think about the synergy portion, you said it's not included within the guidance, but I think you initially had said that you expect some of that to come on pretty quickly.

So how should we think about the cadence of some of those synergies being recognized?

Yes.

I'll comment, and then throw over to Ted a little bit.

So as Darcy said, and it sounds like he was heard and that's good, we have not assumed in our outlook here any effect from -- any positive effect from synergies over the course of the remainder of the fiscal year.

That's consistent with what we said at the time of our -- of the acquisition itself as well as of our subsequent borrowing and equity raise.

That is a conservative assessment.

As Ted mentioned, he's working away at it, and the team's working away at it.

I think the issue is really one of just having a bit more clarity on timing and so forth, and we felt like the more prudent approach was to give you guys about what we know today.

But certainly, if I sort of look at it big picture, we have said that it will take us between 24 and 36 months to realize at least $50 million of synergies, including both revenue and cost.

And from a planning perspective, there is nothing that's going on that would lead me to believe otherwise.

Ted, anything to add there maybe with regard to more recent developments.

No, Jon, I would just echo your sentiments briefly that we're already underway on cost synergies.

We expect to be able to deliver to you a more fulsome review of the actions that we have taken in our next -- in our third quarter call.

And we expect the list of sort of actions, taken with concrete savings associated with them, to be reasonably robust at that time.

Yes.

And it's Darcy, Anne.

I mean we wanted to convey on this call we just closed this transaction 2 business days ago, and we wanted to make sure that we set the current run rate and the expectations of what the business is producing today without any changes that we have implemented.

And we will certainly start implementing those changes.

And just to quantify them but also get the right timing right is very important to us, and so we'll make sure and try to do that when we release our Q3 results and give you some clarity on that.

Our next question comes from Jamie Stockton with Wells Fargo.

I guess maybe just a quick follow-up on Annie's questions.

Jon, this deal closed, I guess, 2-plus months ago.

Wage's numbers are looking a little rough this year.

Are you any less optimistic about this now than you were when you closed it a couple months ago?

Yes.

Thanks, Jamie.

It's an awkward answer because you're one of those analysts who I'm about to say we weren't -- we -- certainly, it includes numbers we were not taking for granted in our assessment of the deal.

If anyone else had asked that question, it will be a lot easier.

But I would say we entered the discussions with Wage with a very sober view of where the company was at, what its challenges were and what we would need to address.

By and large, we were pleased that, that sort of sober approach was reflected, and we ultimately paid for it.

And if anything, if I look at where we are today relative to where we were at closing, the things that you worry about I think the most in this period of time are the things that get really very difficult to really diligent: how hard is it going to be to get each product on one platform; how -- what's the esprit de corps of the team, are people going to be aligned to the mission, that kind of thing; and ultimately, partner client receptivity.

And while obviously it's still early days on some of those points, on others, it's no longer early days.

We have a plan to move the platforms together, and that plan is being implemented as of today.

We have a plan to really deliver Purple service in everything we do.

And that plan, as Ted described, is being implemented today.

And I think most importantly to your point, we have a view as to how the business grows.

And as I said in the earlier comments, at some level, HealthEquity's Q2 results, and as I look a little deeper particularly in the sales results, are highly evaluative of the rationale for this transaction.

We are going to have a product that employers want to buy across all size spectrums that they're telling us they want to buy, and we're going to deliver with the service they expect from us.

And I think if we do that, we're going to look back and see that this was truly transformative in terms of really allowing us, when all is said and done, to both accelerate the underlying growth of our market but I think, for us specifically, really grow our leadership position and cement our position as a leader in the market.

So I guess I'm not surprised that there's a lot of work to do.

We expect that there will be a lot of work to do.

I remember talking with you about some of this before we were in possession of any propriety-type information, and we kind of had that same conversation.

And so it's sort of born out, and that's where I think we are.

Okay.

That's great.

And then maybe just my follow-up.

The trend in interchange revenue on a per-account basis, I think Darcy said it was down 7%.

The kind of uptick in the number of accounts that you're adding, the uptick in the investment balance per account, are these all intertwined in that people are saving more, they're using these as a savings vehicle more incrementally?

Yes.

I mean I think the short answer is yes.

And it's funny when you -- in our prep for this, we prep for that question, and you just gave the answer.

Active accounts were up 13%.

Spend was only up 8%.

Well, what else happened?

Answer, investment.

Investments were up 38%, and investing members were up 31% or vice versa, I can't remember.

But -- and you can see it in the data as people are more ready to spend now.

Now I will say -- more ready to say I would say, I will say, there's some opportunity there because unless you're maxing out, you can do both.

And so there's some more opportunity for us to help our members save more in both directions.

And so there's some more juice we can squeeze out on that one both for us and for our members.

But as I say, the short answer is exactly the one we gave.

Now everyone's -- speaking on the follow-ups, I mean I let you.

I can't tell the end though.

But I mean -- we haven't even gotten to Greg Peters yet.

He can have like -- it doesn't end.

He's going to have it parsed out.

But we have to end.

All right, who's next?

Our next question is from Donald Hooker with KeyBanc.

So in your remarks, Jon, I think you referenced some of the retirement plan partnerships that everyone has been chatting with you about.

I guess I assume you're referring to the Vanguard, Nationwide and Principal.

Is there any way to maybe quantify some of that?

I know those are new, but I think they're reasonably large.

And obviously, everyone's watching for data around those partnerships.

Yes.

I can quantify a little bit of the opportunity, and I'm going to throw to Ted and have him talk through kind of what we're up to there and some of the progress.

If you look at -- as we said before, Don, we don't do these kinds of announcements on every deal that we do.

If the other side wants to do it, we will.

But -- so if I look across all of our retirement partner, recordkeeper partner footprint, our recordkeepers today manage about 12%, 13%, I believe, of defined contribution assets.

And by the way, we expect that, with what's in the pipeline, to grow to about 1/4 of the entire recordkeeper market.

So we feel like we're building a real formidable footprint among retirement plans.

And so to think about that as a way we go to market together to connect health and wealth.

That seems pretty good.

That all sounds great as opportunity.

What I think Ted can talk about a little bit is how we're trying to take advantage of that opportunity with our partners, on the one hand, carefully and soberly but also as quickly as possible.

Ted?

Yes.

Thanks, Jon.

I think we're highly encouraged by the partnerships that we've been able to establish with several recordkeepers, as Jon alluded to, some of whom has been announced publicly and others of whom have not.

We have real deals signed, real accounts on the books already, which is very exciting.

But even more exciting is just the great partnerships that we're finding.

This is a real need for our recordkeeping partners, and they're stepping up to be able to deliver it to their clients, and we're the beneficiary of that.

I think that we are -- we didn't release a target externally.

But internally, we're exceeding the targets that we set for ourselves this year.

We signed up a lot of health plans over the years.

And typically, they develop well, but they develop somewhat slowly.

And thus far, it appears, if you ask our historians at HealthEquity, that these recordkeeper partners have borne fruit probably faster than our health plan partnerships have on average, which is really exciting, but lots of opportunities, lots more work to do, but really encouraging and in excess of our internal targets thus far.

Okay.

Great.

And then maybe my follow-up question, I guess.

Also, Jon, in your prepared remarks, you alluded to some of the IRS guidelines around, I guess, the inclusion of first-dollar coverage of chronic diseases and conditions.

I would think that's a subtle change but very important, I would think, long term.

Maybe I'm wrong, but I would love to hear your view as to how -- just how quick that might translate into employers maybe being more friendly and open to this HSA concept.

Yes.

I'm going to punt that one to Steve Neeleman who's on with us for the Q&A.

And he's been banging the drum for this particular change for a long time precisely because, over the long term, it is important and the right thing to do.

Steve, do you want to speak to that?

Sure.

Thanks, Jon.

So we can assure you that the minute that the reg came out from treasury and HSS that our account executives were on the phone with our largest employers talking about this important change.

And the bottom line is, is that for too long, people with chronic illness, pretty run-of-the-mill stuff that many of us or family members have like diabetes and asthma and high blood pressure and things like that, it's been -- there just been a lack of clarity as to whether these dollars could be paid for by the health plan and not out of somebody's HSA.

Obviously, from our benefit, as a company, it's fantastic if someone can have these conditions treated and not have to use their health savings account dollars to do so or their other account dollars.

And so we've been on the phone talking about it.

Some of the real large employers start plan design discussions for a January 1 enrollment even as early as March or April, and these came out towards the end of July, mid- to end of July.

And so now we're talking to them about it.

The other thing that we're able to do is just to start to educate our members to ask their employers about adding these types of benefits.

But my expectation is, is that it's going to have a long-term effect on the adoption of HSAs.

It may have come out a little bit late for the large employers to make -- and it also helps us to make -- plan event changes for this year.

But we're all over it.

We're talking to our folks about it.

And I think more than anything, you're not only going to be able to see the savings go up and the accounts because of this, I think you'll see more adoption.

But most of all, I think it's a great way to address chronic disease in this country.

As people get older, most Americans, as they get into their 60s, have at least one of these chronic diseases.

And so we're really excited about it.

The employers are thrilled that they don't have to wonder about it anymore, and they can consent -- can start offering it, and the health plans are starting to retool some of their offerings as well to make sure that this is included.

For the midsize and small employers, the midsize folks in particular, I think that there will be some effect this year.

I mean just using ourselves as an example, we're obviously in the middle of finalizing our merge benefits for calendar '20.

And as a company with just under, I guess, about 2,500 or 2,000 employees and as the benefits pros like to call it, people who do work.

And obviously, both our companies have HSA options today.

But this gives us a lot more flexibility to do the right thing both financially for the company in terms of plan design and then also for our teammates in terms of coverage for -- a little incremental coverage for -- a wiggle room for certain conditions, a little incremental certainty.

So I think if we're having that discussion, I suspect that a lot of firms in that kind of maybe not mega size and so forth are having that discussion as well now.

And we'll see those results when open enrollment time comes around in a few months and as accounts come on for January as to whether there's been a meaningful pick-up in enrollment in this year's result.

But certainly, over the long term, as we've commented elsewhere, existing HRA plans really don't make as much sense in this context.

You're likely to see those turn into HSA plans over time.

And many of the existing PPO plans with higher deductibles, you just -- the putt to get that to an HSA plan becomes very short.

And clearly, there's a lot more value with a team member in that context.

So we think it makes sense and right along with everything else we're doing, so thanks.

Our next question comes from Greg Peters with Raymond James.

Thank you for the call-out earlier.

I was impressed, judging from Darcy and Ted's performance, they read their scripts flawlessly.

So I guess you must be off to a good start.

It means that we have at least 5 minutes beforehand, so that's good.

Can I go back to Darcy's comment about the interest rate or the yield on cash AUM?

I think you said 2.54% through the end of the second quarter.

Can you give us some perspective on where the current market is and how we should think about the pressure from lower rates on this very important metric going forward?

Yes.

And we commented about this before that -- and we reiterated our guidance for the full year of being in that 2.5% range.

The way that we ladder out our portfolios, it has a longer-term view.

And in the current rate environment, it is impacted obviously by the rate decrease that happened not only in July but there's -- a year ago this time, they were talking about 4 rate increases, and now they're talking about -- they just did the first rate increase, and who knows how long?

And so longer term, interest rates matter that they make today will impact the go forward.

In the current rate environment, we still believe that we will actually see an uptick a little bit in rate above what we currently are yielding.

But we'll see.

As time -- it's -- there's 2 variables: the amount of assets that we bring on and how quickly we bring on some of the Wage assets onto our platform and how much we grow the assets in this coming season in December and January and then what will the rate environment actually be when we start placing new funds.

But in the current environment, we feel pretty good about it.

But decreasing rates will have an impact just like increasing rates had an impact on us as they came up.

And just as a follow-up, and I'm allowed only 1 follow-up, with the current lower rate environment, have you seen any competitive change in behavior regarding service fees -- service revenue?

You noted in your guidance that you're going to come in, in the high end of the decline of per-account service revenue.

I would anticipate with lower rates that the rate of decline in service revenue would begin to diminish.

Yes, that may be.

I mean as you know, the thing that -- the biggest driver of that is incremental volume on contracts.

But what's correct is these things are intertwined.

And one piece of evidence of that is if you look at, let's say, the flexible spending account business that Wage has a large profile in where you don't have as much of that custodial component or, in their case, didn't have any of that custodial component, fees are more stable, right?

And here, you have variability of these with rates.

And so there is clearly a -- what with the -- if I go back -- I am from Boston, so I can be like all academic and go back to any of those, it's cross-price elasticity.

And so you hear that on earnings calls a lot.

And that having been said, Greg, I think that it is first -- 2 thoughts that I think are relevant.

First is, the reason that the company, as you know, earns a premium to rates out in the marketplace is because we are very reliable in terms of talking to people about what we're going to need and then actually meeting it so they can build an asset portfolio around it and it was a loan portfolio.

And second, because we take on all of the noninterest expense expressed as service, right, associated with accounts.

So it's one transaction in and out a day per bank, and that's that.

And that's why banks participate in our cash program.

And so I think those factors haven't fundamentally changed, and that's a good thing.

So as Darcy said, well, obviously, we're not in the business of giving forward guidance a year out.

We have said because we thought it was useful that we feel like rates going into next year, if the conditions are as they are today, by which I mean broadly if things happen as are presently expected, then we would expect that we'd be able to tick up next year just as we did this year and so forth.

If conditions change or depending on the amount of cash and our ability to predict it and all those kind of factors, that may be slightly different.

But I think broadly, we continue to expect that at least for this period of time that rates will be a positive contributor to margins as well as to revenue growth.

Yes.

The magnitude of the uptick is still to be seen.

Yes.

Our next question is from Stephanie Demko with Citi.

Jon, congrats on closing Wage and for the strong quarter.

So my first question, I'd like to just hear a little bit more about the $80 million to $100 million investment you're making in consolidating Wage's services with your own.

How much of that could be thought of more as run rate costs, like hiring a customer care staff in the U.S. versus onetime?

Or is that just a consequence of location or other?

So let me start, and then I'll kick it over to Ted, and Darcy may want to weigh in as well.

We are trying to be very careful about -- and prior to setting up this entire transaction, we're very careful about what we include in onetime costs.

The wages and salaries of our teammates, for the most part -- well, essentially, with very, very few exceptions, meaning our integration-related cost line, that's not a onetime expense.

In my experience, they don't go away.

And so when we talk about that expense, we're really talking about the things that we need to do that are truly of a onetime nature to meet our commitments that Ted described.

And so that -- the intent of that is to give you some level of confidence that these are truly expenses that are of a onetime nature and that it won't require us twisting our words or the business to be able to report without them.

With that, Ted, it seems like you're in a great position to describe the nature of what we're doing in the investments.

Sure.

Thanks, Jon.

So I think to answer your question, the sort of biggest onetime expense is platform consolidation and harmonization and integration.

That is going to be a process that's going to take 18 to 24 months, and it's going to require a lot of resources.

And that's probably -- in that $80 million to $100 million, that's probably the single biggest expense.

To your question about run rate costs, there will be absolutely incremental run rate costs associated with things like bringing more calls to the U.S., but those are contemplated in the $50 million, meaning that the $50 million is a net number.

We expect some -- I don't know if the fancy word is dissynergies there, but those are kind of embedded within the $50 million synergy target that we have.

So then you're absolutely right, there will be some ongoing expenses associated with some of these investments, but that's how we've planned for it.

Darcy, I don't know if you want to add anything.

Yes.

Just on -- I made several references to the reconciliation.

If you look at our reconciliation to our outlook that's provided in the earnings release, you'll see approximately $27 million in the current fiscal year of acquisition -- excuse me, $29 million of integrated-related costs.

And those are costs that we expect that we will incur between now and January.

And then we will report those as a separate line item in our income statement going forward, so you can keep track of how we're doing towards this integration activity.

That's super helpful, guys.

I really appreciate that clarity.

I would sneak in a housekeeping one, then a follow-up.

Not 2 questions, a follow-up to housekeeping.

So for the housekeeping fees, for the Wage EBITDA estimate, the 15% seems low.

Does that include restatement cost or anything of that nature that would maybe bring it down?

So a couple of thoughts, it's the second half of the year, in particular the last 5 months, which are the most service-intensive.

Obviously, we're being -- I won't say conservative, we're being realistic on the revenue side.

And as Darcy said, we're not making any -- in this estimate, we again -- keeping in mind we had to make it without actually running the business.

So we haven't, for example, incorporated in this any estimate of any adjustments we would make given our view of revenue outside of synergy-type items and then, of course, we have included synergy items.

So we recognize that it is low and -- certainly relative to any annualized number.

But I will say on the -- I'll then have Darcy comment on this, on the audit, et cetera, costs, we're going to adopt to our convention which is we are -- as you know, we're backing out integration costs.

But Stephanie, our view is that, as I said before, the kind of stuff that we will not back out is people who, like, work on an ongoing basis.

And so there is not contemplated a -- there's no add-back there for costs associated with running the business right in terms of its accounting and so which, again, I think, are costs the company would have incurred one way or the other here.

So perhaps that has some impact as well relative to a highly adjusted number that's been reported, but those are the main factors there.

Darcy, anything to add to that.

Yes.

I mean we've worked hard on this, Stephanie, in trying to give some clarity to you but also not putting on something that we don't know at this point in time.

And we're going to learn a heck of a lot in the next 60 days as we start closing books with them and figuring out some of the details around this.

But we do believe that as their revenues have come down this year or even through the second quarter -- on both first and second quarter year-to-date, they were -- the revenues were down.

And they were, frankly, in the middle of being acquired, and they probably didn't devote as much attention to rightsizing the business for those revenue decreases as they did for evaluating this opportunity.

So we will get after that, and we will take a look at the business as it -- as the current revenue that's being produced, and we'll make the appropriate decision to run the business as we see fit.

So those things are all going to come, more so we just -- we wanted to set a baseline for you about what it is that we've inherited today and then go from there.

Okay.

Understood.

That's helpful.

And then for the follow-up, just taking on the revenue synergies, those business optimization synergies, I know you talked about this before, but I think of a lot of them as month 1 events.

Is there anything that will prevent this from happening, like the current environment creating a longer period of time to negotiate your new custodial contracts?

Or is there just some healthy conservatism there?

Well, yes, on a couple of fronts.

I mean up until today, we have not really been able to talk about these providers that have been working with Wage.

And I think we actually have scheduled meetings with them tomorrow.

And so we just -- one, we're cautious about how fast we can make this transition happen.

We've learned from experience when we've acquired custodial platforms that you can't always just move them on day 1. Sometimes, there's contractual things that you have to overcome and just the sheer volume and the movement of them.

So like we said, we'll give you that clarity as soon as we know the appropriate timing.

What we're seeing from day 1 is we're going to get after it on day 1. We're just not sure exactly when the revenue will actually start to materialize, but we will clarify that as soon as we can.

Yes.

And I will say that these partners, they want to do business with us.

Whether it's the card networks or some of the banks they recognize may be in a different position, but folks are coming to us with here's what we can help you do, the card processors, et cetera.

And so what I do feel good about is that we're being approached in a much positive way.

Out of an abundance of caution, we felt that it wasn't appropriate to have these negotiations prior to closed transaction.

And maybe that's one of the things that led the DoJ to feel confident that we were pushing this in the right way and let us go to the next stage of close.

But in any event, I feel as good, if not better, about our opportunities there than I did on the date of signing.

Yes.

And as you know, Stephanie, we never like to promise something before we're pretty confident that we can deliver on the time frame that we define.

Our next question comes from Sandy Draper with SunTrust.

A lot of my questions have been asked and answered, but maybe just to follow up on the $80 million to $100 million investments.

Would this -- should I be thinking about this on top of the incremental investments you guys have already been talking about making in terms of technology?

WageWorks is already -- has been talking about extra spending.

Is this keeping those levels of higher spending and then an additional $80 million to $100 million?

Or does this sort of $80 million to $100 million somewhat encapsulate at least portions of that, if that makes sense?

Yes, Sandy.

Certainly, on top of the initiatives that we announced in our fourth quarter call, I believe, this would be on top of that, that $30 million initiative that we talked about.

With respect to Wage, some of their initiatives were focused heavily on HSA deployment.

And so we believe that some of those can be thought of as being that we have provided that platform.

And so we'll sort through that.

But certainly, with respect to the ones that we've announced previously, this $80 million to $100 million is on top of that.

And what it boils down to is there are things you got less of and there are things you got more of.

I mean so are we going to spend what we would've spent, let's say, to launch a Commuter benefits product?

Of course, not, right?

But conversely, one of the things we're promising our customers is a very high level of security and deployment of really meaningful privacy protections.

And so we're going to be doing that across our platform.

And so it's a little hard to keep -- kind of keep track.

But I think in general, the way you should look at it is the P&L that we've guided to is the P&L that would exist inclusive of those investment period, and then there's a WageWorks component and their synergies.

And so that's the way to think about it.

Our next question comes from Mark Marcon with Baird.

Can you hear me?

Yes, sir.

Great.

With regards to just thinking through the 15% margin, obviously, there's seasonality within the Wage business.

How would you translate that 15% to kind of an annualized run rate where we take into account some of the higher margins that you typically get in the first and second quarter and how we think about a base?

I recognize it's only just 2 days since closing, so maybe premature, but just trying to get a feel for it.

Yes.

Appreciate that, Mark.

So if you look at the $170 million to $175 million of revenue we expect in the 5-month period, if you translate that into a fully run rate, that would be in the $410 million to $420 million run rate, which is probably -- I think it's 12% off of their revenue last year.

As far as margin is concerned, because this 5-month is the cost-intensive heavy part of that EBITDA margin, the 15%, we would view their overall annualized rate to be more in the 20% range of EBITDA which is obviously down from the level of where Wage has been previously on their adjusted EBITDA.

But that would be kind of where we would expect it to start from, is the 20% adjusted EBITDA margin.

Yes.

I mean it's actually pretty simple math, Mark.

I mean if you take, first of all, right, like give or take, I believe, $175 million is 5/12 of $420 million, so that's kind of where you get Darcy's revenue number.

And then if you -- basically, the way to think about it is if, as Darcy suggested a few minutes ago, you change revenue without substantially changing expenses, well, guess what happens?

You get less margin.

We don't think that's a real baseline.

That is to say I don't think anyone would operate the business that way nor will we.

But it is what we received.

And so we have to take the actions that WageWorks' management would have taken.

And additionally, we have to take -- as well as continue on the synergy path.

And so I think the good news on this, from my perspective, is that if you look at the longer term here, and I don't think you have to get too long, 2 things are clearly true: one is that there are many opportunities to be more efficient as we grow from an OpEx perspective, I'm going to start there; and I think while certainly there will be some displacement and the like as a result of that, in my view, we can do -- there is enough room to do everything that we need to do to put margins to where they need to be and deliver Purple in everything we do.

That's pretty clear.

The second piece of good news, in my mind, is that from a gross margin perspective, and we said some of this at the time we announced the transaction, I think there are sort of this idea in people's heads that Wage's business is -- somehow is ultimately a lower-margin business than ours.

And the truth is that relative to our current average gross margins, which are pretty gaudy at least by the standard of service business, the underlying real gross margins in this business are very compelling.

We just have to get back to them.

And then certainly with synergies, and particularly with more conversion of the customer base, the HSAs and the like, they can be extremely compelling.

And so what Darcy said is we wanted to give you an honest sense of where we're starting and do it in a way where you could replicate the math so there's no like black box but, at the same time, nobody's thinking that that's where we're going to end up here.

We're going to end up with a combined business that is highly attractive from both a gross margin and ultimately operating margin perspective and, in our view, one that will continue to grow.

I certainly appreciate that.

So the follow-up just as it relates to the integration plan, I just want to make sure I heard a few things correctly and understand the sequencing.

The $80 million to $100 million in investments, is that all integration?

Or is some of that what you would say are investments that would be ongoing?

And is that -- did I hear 24 to 36 months for the full integration to be complete?

Correct.

$80 million to $100 million of what we think of as through onetimers and with the results to be completed within 24 to 36 months.

The investment itself will probably happen a little quicker than that.

It just takes a little time to, as a thumb rule, to get the results.

But we think of these as onetime over and above our CapEx program.

Thanks, Mark.

He gave you the hook, man.

Go ahead, go ahead.

Richard is looking at me like I did the hard work and now you're letting them back.

Go ahead, Mark.

I just wanted to ask just with regards to the sequencing of the integration, how quickly do you think the custodial assets could potentially come over in terms of the HSA custodial assets to your platform?

Like what's...

Well, we're going to start talking about it with the parties on the other end of the discussions tomorrow.

I believe, Cordell will be having that meeting about 9:30 a.m.

in person.

Yes.

I mean the reason that we didn't give any clarity on that timing because we don't know the timing yet, but we are going to work diligently to make it happen as quickly as we can.

If they would have flown on Labor Day, they'd have been here already.

I mean that's a mark against people.

What can you do?

No, kidding.

That means we'll have an answer by the time we get to our conference, right?

Nicely played.

I'm sorry Jamie didn't pull out that card.

And our last question is from Allen Lutz with Bank of America.

Jon, you said you've begun the partnership investments, but the adjusted EBITDA margin in the quarter was 47%.

Can you talk about how much spending you've done to date and then how much you expect in the back half of the year?

Yes.

So Darcy, you want to hit this one?

I think if I understand the question, Allen, what you're asking about is, with regard to sort of the stand-alone Wage, effectively, we ended up with -- I think you said the same, of the $30 million as it were, what we spend the first half, whether we can say...

Yes.

I mean the ramp-up, if you look at our sequential, we ended about $100 million -- I'm just looking at the technology spend.

There are some other areas where we do it.

We've added about $100 million sequentially this quarter.

We tried to do more of that as we were going, and we've actually been able to hire more people.

So we would expect that, that will continue to ramp up throughout the third and fourth quarter on some of those initiatives that we've already started.

Yes.

I mean it's -- we're very fortunate.

I mean I'll have to admit it, if we had known at the beginning of the year that some other things were going to break our way, we probably wouldn't have made such a big deal of this because we could have just done it and there wouldn't have been much talk about.

But as it's turned out that we've been able to make -- both on the spend side as well as the CapEx side, we've been able to ramp up investments in this area and offset that, to some extent, with efficiencies elsewhere in the business while that's been going on.

I mean as an example, one of the items that -- just one example, one of the items that we were doing was -- from our perspective, which was important for security as well as long-term of making the best use of our member services agents, we changed out our telephony platform.

And it's a project that could have easily taken all year, and it actually went live also yesterday so -- or Saturday I should say.

Thank you for those who stayed over the weekend.

So the team's been really good about -- I think even while this whole WageWorks thing has been going on, Ashley and her team have just been fantastic about kind of keeping our -- both our investments going but also trying to be efficient about it and be efficient on other things we're doing.

That's helpful.

And then if EBITDA margins for Wage come in above 20% for all of 2019 or, I guess, above 15% for the back half of the year, can you talk about where you see the most confidence of things that could drive a higher margin profile in that 15%?

Or what are some of the things that could get you above that threshold?

Yes.

Probably the biggest items are the ones that have been mentioned here.

That is to say, on the revenue side, the ability to deploy cash more quickly and move the -- both whether the HSA or the non-HSA cash more quickly, it's certainly one that's out there.

And it has huge impacts as it all drops bottom line.

The other thing that I would say is that from a cost perspective, that Ted and the team, while they have appropriately kept the focus of our team members on what we're doing going forward, they've also been very clear that there are cost reduction opportunities.

And they're -- as Ted reminded me yesterday, they're getting on it.

Meaning relative to other transactions that he's been involved in, it's rare, from his perspective, that on day 1, you have a really well-defined cost plan that's out there over the course of the next 60 days, 90 days, 120 days.

And so there are opportunities on both sides.

I'd say the revenue side is probably a little more powerful just because it all drops to the bottom line immediately, but there are cost opportunities as well.

And there is no more question in the queue.

I would like to turn the call back to Mr. Kessler for his final remarks.

Well, thanks, everybody, and we will look forward to the conferences this week.

As Darcy said several times, we know that folks would like more detail, and we will provide it on a regular basis as we have.

And other than that, thanks to the team for the hard work.

Thanks to everybody.

And we've got a sales season to close here, too, so we'll have a lot to talk about in that regard in December as well.

Thanks, all.

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

This concludes the program, and you may all disconnect.

Have a wonderful day.