The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "plan," "project," "seek," "should," "target," "will," "would" and similar expressions or variations intended to identify forward-looking statements. Such statements include, but are not limited to, statements concerning our ability to integrate the acquisition of Further, the impact of the ongoing COVID-19 pandemic on the Company, the anticipated synergies and other benefits of the acquisitions ofWageWorks and Further, health savings accounts and other tax-advantaged consumer-directed benefits, tax and other regulatory changes, market opportunity, our future financial and operating results, our investment and acquisition strategy, our sales and marketing strategy, management's plans, beliefs and objectives for future operations, technology and development, economic and industry trends or trend analysis, expectations about seasonality, opportunity for portfolio purchases and other acquisitions, operating expenses, anticipated income tax rates, capital expenditures, cash flows and liquidity. These statements are based on the beliefs and assumptions of our management based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk factors" included in our Annual Report on Form 10-K for the fiscal year endedJanuary 31, 2021 , this Quarterly Report on Form 10-Q, and our other reports filed with theSEC . Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such events.
Overview
We are a leader and an innovator in providing technology-enabled services that empower consumers to make healthcare saving and spending decisions. We use our innovative technology to manage consumers' tax-advantaged health savings accounts ("HSAs") and other consumer-directed benefits ("CDBs") offered by employers, including flexible spending accounts and health reimbursement arrangements ("FSAs" and "HRAs"), and to administer Consolidated Omnibus Budget Reconciliation Act ("COBRA"), commuter and other benefits. As part of our services, we and our subsidiaries provide consumers with healthcare bill evaluation and payment processing services, personalized benefit information including information on treatment options and comparative pricing, access to remote and telemedicine benefits, the ability to earn wellness incentives, and investment advice to grow their tax-advantaged healthcare savings. The core of our offerings is the HSA, a financial account through which consumers spend and save long-term for healthcare expenses on a tax-advantaged basis. As ofOctober 31, 2021 , we administered 6.2 million HSAs, with balances totaling$16.4 billion , which we call HSA Assets. Also, as ofOctober 31, 2021 , we administered 7.1 million complementary CDBs. We refer to the aggregate number of HSAs and other CDBs that we administer as Total Accounts, of which we had 13.3 million as ofOctober 31, 2021 . We reach consumers primarily through relationships with their employers, which we call Clients. We reach Clients primarily through a sales force that calls on Clients directly, relationships with benefits brokers and advisors, and integrated partnerships with a network of health plans, benefits administrators, benefits brokers and consultants, and retirement plan recordkeepers, which we callNetwork Partners . We have increased our share of the growing HSA market from 4% in calendar year 2010 to 17% as ofOctober 31, 2021 , measured by HSA Assets. According to Devenir, we are the largest HSA provider by accounts and second largest by assets as ofJune 2021 . In addition, we believe we are the largest provider of other CDBs. We seek to differentiate ourselves through our proprietary technology, product breadth, ecosystem connectivity, and service- -20- -------------------------------------------------------------------------------- Table of Contents driven culture. Our proprietary technology allows us to help consumers optimize the value of their HSAs and other CDBs and gain confidence and skills in managing their healthcare costs as part of their financial security. Our ability to assist consumers is enhanced by our capacity to securely share data in both directions with others in the health, benefits, and retirement ecosystems. Our commuter benefits offering also leverages connectivity to an ecosystem of mass transit, ride hailing, and parking providers. These strengths reflect our "DEEP Purple" culture of remarkable service to customers and teammates, achieved by driving excellence, ethics, and process into everything we do. We earn revenue primarily from three sources: service, custodial, and interchange. We earn service revenue mainly from fees paid by Clients on a recurring per-account per-month basis. We earn custodial revenue mainly from HSA Assets held at our members' direction in federally insured cash deposits, insurance contracts or mutual funds, and from investment of Client-held funds. We earn interchange revenue mainly from fees paid by merchants on payments that our members make using our physical payment cards and on our virtual payment system. See "Key components of our results of operations" for additional information on our sources of revenue, including the adverse impacts caused by the ongoing COVID-19 pandemic. WageWorks Acquisition OnAugust 30, 2019 , we completed the acquisition ofWageWorks, Inc. (the "WageWorks Acquisition") and paid approximately$2.0 billion in cash toWageWorks stockholders, financed through net borrowings of approximately$1.22 billion under our prior term loan facility and approximately$816.9 million of cash on hand. As a result of the WageWorks Acquisition,WageWorks Inc. became a wholly owned subsidiary ofHealthEquity, Inc. The key strategy of the WageWorks Acquisition was to enable us to increase the number of our employer sales opportunities, the conversion of these opportunities to Clients, and the value of Clients in generating members, HSA Assets and complementary CDBs.WageWorks' historic strength of selling to employers directly and through health benefits brokers and advisors complemented our distribution throughNetwork Partners . WithWageWorks' CDB capabilities, we provide employers with a single partner for both HSAs and other CDBs, which is preferred by the vast majority of employers according to research conducted for us byAite Group . For Clients that partner with us in this way, we believe we can produce more value by encouraging both CDB participants to contribute to HSAs and HSA-only members to take advantage of tax savings available through other CDBs. Accordingly, we believe that there are significant opportunities to expand the scope of services that we provide to our Clients. We are continuing our multi-year integration effort that we expect will produce long-term cost savings and revenue synergies. We have identified opportunities of approximately$80 million in annualized ongoing net synergies to be achieved by the end of fiscal year 2022, of which approximately$75 million were achieved as ofOctober 31, 2021 . Furthermore, we anticipate generating additional revenue synergies over the longer-term as our combined distribution channels and existing client base take advantage of the broader service offerings and as we continue to drive member engagement. We estimate non-recurring costs to achieve these synergies of approximately$110 million resulting from investment in technology we use to provide our services, and to run our back-office systems, and from integration of technology, as well as rationalization of cost of operations. Merger integration expenses attributable to theWageWorks Acquisition are expected to be completed by the end of fiscal year 2022, with the exception of ongoing lease expense related to certainWageWorks offices that have been permanently closed, less any related sublease income. As ofOctober 31, 2021 , we had incurred a total of$104 million of non-recurring merger integration costs related to the WageWorks Acquisition. Luum Acquisition InMarch 2021 , we bolstered our commuter offering by acquiring 100% of the outstanding capital stock ofFort Effect Corp , d/b/a Luum (the "Luum Acquisition") for an aggregate purchase price consisting of$50.2 million in cash and up to$20.0 million in contingent payments payable during the two-year period following the closing of the Luum Acquisition. OnOctober 31, 2021 , we entered into an amendment to the purchase agreement to pay$6.0 million in satisfaction of the contingent consideration liability. Luum provides employers with a suite of commute tools as well as real-time commute data, to help them design and implement flexible return-to-office and hybrid-workplace strategies and benefits. Fifth Third Bank HSA portfolio acquisition InApril 2021 , we entered into a definitive agreement withFifth Third Bank , National Association ("Fifth Third"), to transition the custody of Fifth Third's HSA portfolio toHealthEquity . OnSeptember 29, 2021 , the transaction was closed, in which we paid a$60.8 million purchase price for a transfer of approximately 160,000 HSAs and -21- -------------------------------------------------------------------------------- Table of Contents$491.0 million of HSA Assets. The agreement includes a mechanism to adjust the purchase price based on the amount of HSA Assets actually transferred. Further Acquisition InApril 2021 , we entered into a definitive agreement to acquire Further for$500 million . Further is a leading provider of HSA and other CDB administration services, with approximately 580,000 HSAs and$1.9 billion of HSA Assets. InSeptember 2021 , the terms of the acquisition were amended pursuant to two agreements: (1) an amended agreement to acquire Further (other than VEBA, as described below) for$455 million , which closed onNovember 1, 2021 , and (2) an agreement to acquire all cash balances and investment assets included in any voluntary employee beneficiary association ("VEBA") account that is funding a health reimbursement arrangement (either Section 501(c)(9) or Section 115 trusts) and all contracts related exclusively thereto, subject to satisfaction of certain customary closing conditions, for a maximum purchase price of$45 million , calculated based on the actual amount of VEBA assets transferred relative to the total amount of VEBA assets as ofApril 30, 2021 . OnDecember 3, 2021 , the parties agreed to terminate the agreement to acquire the Further VEBA business. HealthSavings HSA portfolio acquisition OnDecember 6, 2021 , we entered into a definitive agreement withHealth Savings Administrators, L.L.C. ("HealthSavings") to transition the custody of HealthSavings' HSA portfolio toHealthEquity . The definitive agreement provides a$60 million purchase price for approximately$1.3 billion of HSA assets held in approximately 87,000 HSAs. Given that a significant portion of the HSA assets are currently invested, HealthSavings andHealthEquity are working closely to coordinate an in-kind transfer of most of the invested assets. The transition of HealthSavings' HSAs to theHealthEquity platform is expected to be completed in the first quarter of fiscal 2023. Key factors affecting our performance We believe that our future performance will be driven by a number of factors, including those identified below. Each of these factors presents both significant opportunities and significant risks to our future performance. See also "Results of operations - Revenue" for information relating to the ongoing COVID-19 pandemic and also the section entitled "Risk factors" included in our Annual Report on Form 10-K for the fiscal year endedJanuary 31, 2021 , this Quarterly Report on Form 10-Q, and our other reports filed with theSEC . Structural change inU.S. health insurance We derive revenue primarily from healthcare-related saving and spending by consumers in theU.S. , which are driven by changes in the broader healthcare industry, including the structure of health insurance. The average premium for employer-sponsored health insurance has risen by 22% since 2016 and 47% since 2011, resulting in increased participation in HSA-qualified health plans and HSAs and increased consumer cost-sharing in health insurance more generally. We believe that continued growth in healthcare costs and related factors will spur continued growth in HSA-qualified health plans and HSAs and may encourage policy changes making HSAs or similar vehicles available to new populations such as individuals in Medicare. However, the timing and impact of these and other developments inU.S. healthcare are uncertain. Moreover, changes in healthcare policy, such as "Medicare for all" plans, could materially and adversely affect our business in ways that are difficult to predict. Trends inU.S. tax law Tax law has a profound impact on our business. Our offerings to members, Clients, andNetwork Partners consist primarily of services enabled, mandated, or advantaged by provisions ofU.S. tax law and regulations. Changes in tax policy are speculative, and may affect our business in ways that are difficult to predict. Our client base Our business model is based on a B2B2C distribution strategy, whereby we work withNetwork Partners and Clients to reach consumers to increase the number of our members with HSA accounts and complementary CDBs. We believe that there are significant opportunities to expand the scope of services that we provide to our current Clients. Broad distribution footprint We believe we have a diverse distribution footprint to attract newClients and Network Partners . Our sales force calls on enterprise and regional employers in industries across theU.S. , as well as potentialNetwork Partners from among health plans, benefits administrators, and retirement plan record keepers. -22- -------------------------------------------------------------------------------- Table of Contents Product breadth We are the largest custodian and administrator of HSAs (by number of accounts), as well as a market-share leader in each of the major categories of complementary CDBs, including FSAs and HRAs, COBRA and commuter benefits administration. Our Clients and their benefits advisors increasingly seek HSA providers that can deliver an integrated offering of HSAs and complementary CDBs. With our CDB capabilities, we can provide employers with a single partner for both HSAs and complementary CDBs, which is preferred by the vast majority of employers, according to research conducted for us byAite Group . We believe that the combination of HSA and complementary CDB offerings significantly strengthens our value proposition to employers, health benefits brokers and consultants, andNetwork Partners as a leading single-source provider. Our proprietary technology We believe that innovations incorporated in our technology, which enable us to better assist consumers to make healthcare saving and spending decisions and maximize the value of their tax-advantaged benefits, differentiate us from our competitors and drive our growth. We built on these innovations by combining our HSA offering withWageWorks' complementary CDB offerings, giving us a full suite of CDB products, and adding to our solutions set and leadership position within the HSA sector. We intend to continue to invest in our technology development to enhance our capabilities and infrastructure, while maintaining a focus on data security and the privacy of our customers' data. For example, we are making significant investments in the architecture and infrastructure of the technology that we use to provide our services to improve our transaction processing capabilities and support continued account and transaction growth, as well as in data-driven personalized engagement to help our members spend less, save more, and build wealth for retirement. Our "DEEP Purple" service culture The successful healthcare consumer needs education and guidance delivered by people as well as by technology. We believe that our "DEEP Purple" culture, which we define as driving excellence, ethics, and process while providing remarkable service, is a significant factor in our ability to attract and retain customers and to address nimbly, opportunities in the rapidly changing healthcare sector. We make significant efforts to promote and foster DEEP Purple within our workforce. We invest in and intend to continue to invest in human capital through technology-enabled training, career development, and advancement opportunities. Interest rates As a non-bank custodian, we contract with federally insured banks and credit unions, which we collectively call ourDepository Partners , and also with insurance company partners, to hold custodial cash assets on behalf of our members. We earn a material portion of our total revenue from interest paid to us by these partners. Custodial cash assets held by our insurance company partners are held in group annuity contracts and similar arrangements. The lengths of our agreements withDepository Partners typically range from three to five years and may have fixed or variable interest rate terms. The terms of new and renewing agreements with ourDepository Partners may be impacted by the then-prevailing interest rate environment, which in turn is driven by macroeconomic factors and government policies over which we have no control. Such factors, and the response of our competitors to them, also determine the amount of interest retained by our members. We believe that diversification ofDepository Partners and insurance company partners, varied contract terms and other factors reduce our exposure to short-term fluctuations in prevailing interest rates and mitigate the short-term impact of sustained increases or declines in prevailing interest rates on our custodial revenue. Over longer periods, sustained shifts in prevailing interest rates affect the amount of custodial revenue we can realize on custodial assets and the interest retained by our members. Although interest rates have improved somewhat, we expect our custodial revenue to continue to be adversely affected by the interest rate cuts by theFederal Reserve associated with the ongoing COVID-19 pandemic, the lack of demand fromDepository Partners for deposits, and other market conditions that have caused the interest rates offered by ourDepository Partners to decline significantly. Interest on our five-year senior secured term loan A facility (the "Term Loan Facility") changes frequently due to variable interest rate terms, and as a result, our interest expense is expected to fluctuate based on changes in prevailing interest rates. Our competition and industry Our direct competitors are HSA custodians and other CDB providers. Many of these are state or federally chartered banks and other financial institutions for which we believe benefits administration services are not a core business. Some of our direct competitors (including healthcare service companies such asUnited Health Group's Optum,Webster Bank , and well-known retail investment companies, such asFidelity Investments ) are in a position to -23- -------------------------------------------------------------------------------- Table of Contents devote more resources to the development, sale, and support of their products and services than we have at our disposal. In addition, numerous indirect competitors, including benefits administration service providers, partner with banks and other HSA custodians to compete with us. OurNetwork Partners may also choose to offer competitive services directly, as some health plans have done. Our success depends on our ability to predict and react quickly to these and other industry and competitive dynamics. As a result of the COVID-19 pandemic, we have seen an adverse impact on sales opportunities, with some opportunities delayed and most now being held virtually. We have seen a significant decline in the use of commuter benefits due to many of our members working from home during the outbreak or other impacts from the outbreak, which has negatively impacted both our interchange revenue and service revenue, and this "work from home" trend may continue after the pandemic. We have also seen a decline in interchange revenue across all other products. The extent to which the COVID-19 pandemic will negatively impact our business remains highly uncertain and cannot be accurately predicted. Regulatory environment Federal law and regulations, including the Affordable Care Act, the Internal Revenue Code, theEmployee Retirement Income Security Act and Department of Labor regulations, and public health regulations that govern the provision of health insurance and provide the tax advantages associated with our services, play a pivotal role in determining our market opportunity. Privacy and data security-related laws such as the Health Insurance Portability and Accountability Act, or HIPAA, and the Gramm-Leach-Bliley Act, laws governing the provision of investment advice to consumers, such as the Investment Advisers Act of 1940, or the Advisers Act, theUSA PATRIOT Act, anti-money laundering laws, and the Federal Deposit Insurance Act, all play a similar role in determining our competitive landscape. In addition, state-level regulations also have significant implications for our business in some cases. For example, our subsidiaryHealthEquity Trust Company is regulated by theWyoming Division of Banking , and several states are considering, or have already passed, new privacy regulations that can affect our business. Various states also have laws and regulations that impose additional restrictions on our collection, storage, and use of personally identifiable information. Privacy regulation in particular has become a priority issue in many states, includingCalifornia , which in 2018 enacted the California Consumer Privacy Act broadly regulatingCalifornia residents' personal information and providingCalifornia residents with various rights to access and control their data, and the new California Privacy Rights Act. We have also seen an increase in regulatory changes related to our services due to government responses to the COVID-19 pandemic and may continue to see additional regulatory changes. Our ability to predict and react quickly to relevant legal and regulatory trends and to correctly interpret their market and competitive implications is important to our success. OnMarch 21, 2021 , the American Rescue Plan Act of 2021 ("ARPA") was signed into law. ARPA temporarily increased the dependent care flexible spending account contribution limit for the 2021 plan year. It also provided a temporary 100% subsidy of COBRA premium payments for eligible individuals who lost coverage due to an involuntary termination or a reduction of hours for up to 6 months. Our acquisition strategy We have a successful history of acquiring HSA portfolios and businesses that strengthen our service offerings. We seek to continue this growth strategy and are regularly engaged in evaluating different opportunities. We have developed an internal capability to source, evaluate, and integrate acquired HSA portfolios. We intend to continue to pursue acquisitions of complementary assets and businesses that we believe will strengthen our service offering, and our success depends in part on our ability to successfully integrate acquired businesses and HSA portfolios with our business in an efficient and effective manner. -24- -------------------------------------------------------------------------------- Table of Contents Key financial and operating metrics Our management regularly reviews a number of key operating and financial metrics to evaluate our business, determine the allocation of our resources, make decisions regarding corporate strategies and evaluate forward-looking projections and trends affecting our business. We discuss certain of these key financial metrics, including revenue, below in the section entitled "Key components of our results of operations." In addition, we utilize other key metrics as described below. Total Accounts The following table sets forth our HSAs, CDBs, and Total Accounts as of and for the periods indicated: (in thousands, except percentages) October 31, 2021 October 31, 2020 % Change January 31, 2021 HSAs 6,241 5,460 14 % 5,782 New HSAs from sales - Quarter-to-date 151 104 45 % 370 New HSAs from sales - Year-to-date 446 317 41 % 687 New HSAs from acquisitions - Year-to-date 160 - n/a - HSAs with investments 431 302 43 % 333 CDBs 7,085 7,060 0 % 7,028 Total Accounts 13,326 12,520 6 % 12,810 Average Total Accounts - Quarter-to-date 13,247 12,084 10 % 12,659 Average Total Accounts - Year-to-date 13,158 12,429 6 % 12,604 The number of our HSAs and CDBs are key metrics because our revenue is driven by the amount we earn from them. The number of our HSAs increased by approximately 0.8 million, or 14%, fromOctober 31, 2020 toOctober 31, 2021 , due to further penetration into existingNetwork Partners , the addition of newNetwork Partners , and HSA portfolio acquisitions. The number of our CDBs increased slightly fromOctober 31, 2020 toOctober 31, 2021 , driven by an increase in COBRA and HRA accounts, largely offset by a decrease in FSA accounts and also commuter benefit accounts that are currently suspended due to the COVID-19 pandemic and fewer workers being required to commute to an office. The suspended commuter accounts continue to be administered on our platform and can be reinstated at any time. We have excluded the suspended commuter accounts from our account totals because they are currently not generating revenue for the Company. HSA Assets The following table sets forth HSA Assets as of and for the periods indicated: October 31, October
31,
(in millions, except percentages) 2021 2020 % Change January 31, 2021 HSA cash with yield (1)$ 10,410 $ 8,759 19 % $ 9,875 HSA cash without yield (2) 59 258 (77) % 244 Total HSA cash 10,469 9,017 16 % 10,119 HSA investments with yield (1) 5,900 3,255 81 % 4,078 HSA investments without yield (2) 59 168 (65) % 138 Total HSA investments 5,959 3,423 74 % 4,216 Total HSA Assets 16,428 12,440 32 % 14,335 Average daily HSA cash with yield - Year-to-date 9,925 8,445 18 % 8,599 Average daily HSA cash with yield - Quarter-to-date$ 10,099 $ 8,672 16 % $ 9,060 (1)HSA Assets that generate custodial revenue. (2)HSA Assets that do not generate custodial revenue. HSA Assets, which are our HSA members' assets for which we are the custodian or administrator, or from which we generate custodial revenue, consist of the following components: (i) HSA cash, which includes cash deposits with ourDepository Partners or other custodians and cash placed in group annuity contracts with our insurance company partners, and (ii) HSA investments in mutual funds through our custodial investment fund partners. We are continuing to transition HSA cash without yield to HSA cash with yield and expect to complete the transition in fiscal year 2022. Measuring HSA Assets is important because our custodial revenue is directly affected by average daily custodial balances for HSA Assets that are revenue generating. -25- -------------------------------------------------------------------------------- Table of Contents Total HSA cash increased by$1.5 billion , or 16%, fromOctober 31, 2020 toOctober 31, 2021 , due primarily to HSA contributions, new HSAs, and acquisitions of HSA portfolios, partially offset by transfers to HSA investments. HSA investments increased by$2.5 billion , or 74%, fromOctober 31, 2020 toOctober 31, 2021 , due primarily to transfers from HSA cash and appreciation of invested balances. Total HSA Assets increased by$4.0 billion , or 32%, fromOctober 31, 2020 toOctober 31, 2021 , due primarily to HSA contributions, new HSAs, acquisitions of HSA portfolios, and appreciation of invested balances. Client-held funds (in millions, except percentages) October 31, 2021 October 31, 2020 % Change January 31, 2021 Client-held funds (1) $ 811 $ 798 2 % $ 986 Average daily Client-held funds - Year-to-date (1) 849 847 - % 847 Average daily Client-held funds - Quarter-to-date (1) 796 819 (3) % 848 (1) Client-held funds that generate custodial revenue. Client-held funds are interest-earning deposits from which we generate custodial revenue. These deposits are amounts remitted by Clients and held by us on their behalf to pre-fund and facilitate administration of CDBs. We deposit the Client-held funds with ourDepository Partners in interest-bearing, demand deposit accounts that have a floating interest rate and no set term or duration. Client-held funds fluctuate depending on the timing of funding and spending of CDB balances. Adjusted EBITDA We define Adjusted EBITDA, which is a non-GAAP financial metric, as adjusted earnings before interest, taxes, depreciation and amortization, amortization of acquired intangible assets, stock-based compensation expense, merger integration expenses, acquisition costs, gains and losses on equity securities, and certain other non-operating items. We believe that Adjusted EBITDA provides useful information to investors and analysts in understanding and evaluating our operating results in the same manner as our management and our board of directors because it reflects operating profitability before consideration of non-operating expenses and non-cash expenses, and serves as a basis for comparison against other companies in our industry. The following table presents a reconciliation of net income (loss), the most comparable GAAP financial measure, to Adjusted EBITDA for the periods indicated: Three months ended October 31, Nine months ended October 31, (in thousands) 2021 2020 2021 2020 Net income (loss)$ (5,038) $ 1,789 $ (11,471) $ 3,467 Interest income (478) (174) (1,419) (850) Interest expense 11,881 6,952 25,824 28,110 Income tax provision (benefit) (4,087) 2,340 (11,505) 2,015 Depreciation and amortization 13,904 10,253 38,619 28,580 Amortization of acquired intangible assets 19,642 19,126 59,745 56,905 Stock-based compensation expense 13,284 11,479 41,700 30,313 Merger integration expenses 13,244 8,193 38,422 31,328 Acquisition costs (gains) (1) (2,687) 13 4,917 79 Gain on equity securities - - (1,677) - Other (2) 1,422 1,168 2,421 4,202 Adjusted EBITDA$ 61,087 $ 61,139 $ 185,576 $ 184,149 (1)For the nine months endedOctober 31, 2021 , acquisition costs included$0.3 million of stock-based compensation expense. (2)For the three months endedOctober 31, 2021 , other consisted of amortization of incremental costs to obtain a contract of$0.8 million and other expenses, net, of$0.6 million . For the three months endedOctober 31, 2020 , other consisted of amortization of incremental costs to obtain a contract of$0.6 million and other expenses, net, of$0.6 million . For the nine months endedOctober 31, 2021 , other consisted of amortization of incremental costs to obtain a contract of$3.5 million , partially offset by other income, net, of$1.0 million . For the nine months endedOctober 31, 2020 , other consisted of amortization of incremental costs to obtain a contract of$1.4 million and other expenses, net, of$2.8 million . -26- -------------------------------------------------------------------------------- Table of Contents The following table further sets forth our Adjusted EBITDA as a percentage of revenue: Three months ended October 31, Nine months ended October 31, (in thousands, except percentages) 2021 2020 $ Change % Change 2021 2020 $ Change % Change Adjusted EBITDA$ 61,087 $ 61,139 $ (52) - %$ 185,576 $ 184,149 $ 1,427 1 % As a percentage of revenue 34 % 34 % 34 % 34 % Our Adjusted EBITDA was$61.1 million for each of the three month periods endedOctober 31, 2021 and 2020. Our Adjusted EBITDA increased by$1.4 million , or 1%, from$184.1 million for the nine months endedOctober 31, 2020 to$185.6 million for the nine months endedOctober 31, 2021 , which reflects a similar increase in total revenue from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 . Our use of Adjusted EBITDA has limitations as an analytical tool, and it should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Key components of our results of operations Revenue We generate revenue from three primary sources: service revenue, custodial revenue, and interchange revenue. Service revenue. We earn service revenue from the fees we charge our Network Partners, Clients, and members for the administration services we provide in connection with the HSAs and other CDBs we offer. With respect to ourNetwork Partners and Clients, our fees are generally based on a fixed tiered structure for the duration of the relevant service agreement and are paid to us on a monthly basis. We recognize revenue on a monthly basis as services are rendered to our members and Clients. Custodial revenue. We earn custodial revenue primarily from HSA Assets deposited with ourDepository Partners and with our insurance company partners, recordkeeping fees we earn in respect of mutual funds in which our members invest, and Client-held funds deposited with ourDepository Partners . We deposit HSA cash with ourDepository Partners pursuant to contracts that (i) typically have terms ranging from three to five years, (ii) provide for a fixed or variable interest rate payable on the average daily cash balances deposited with the relevant Depository Partner, and (iii) have minimum and maximum required deposit balances. HSA cash placed with our insurance company partners is placed in group annuity contracts or similar arrangements. We deposit the Client-held funds with ourDepository Partners in interest-bearing, demand deposit accounts that have a floating interest rate and no set term or duration. We earn custodial revenue on HSA Assets and Client-held funds that is based on the interest rates offered to us by theseDepository Partners and insurance company partners. In addition, once a member's HSA cash balance reaches a certain threshold, the member is able to invest his or her HSA Assets in mutual funds through our custodial investment partner. We earn a recordkeeping fee, calculated as a percentage of custodial investments. We are continuing to transition HSA cash without yield to HSA cash with yield and expect to complete the transition in fiscal year 2022. Interchange revenue. We earn interchange revenue each time one of our members uses one of our physical payment cards or virtual platforms to make a purchase. This revenue is collected each time a member "swipes" our payment card to pay expenses. We recognize interchange revenue monthly based on reports received from third parties, namely, the card-issuing banks and card processors. Cost of revenue Cost of revenue includes costs related to servicing accounts, managing Client and Network Partner relationships and processing reimbursement claims. Expenditures include personnel-related costs, depreciation, amortization, stock-based compensation, common expense allocations (such as office rent, supplies, and other overhead expenses), new member and participant supplies, and other operating costs related to servicing our members. Other components of cost of revenue include interest retained by members on HSA cash and interchange costs incurred in connection with processing card transactions for our members. Service costs. Service costs include the servicing costs described above. Additionally, for new accounts, we incur on-boarding costs associated with the new accounts, such as new member welcome kits, the cost associated with issuance of new payment cards, and costs of marketing materials that we produce for ourNetwork Partners . Custodial costs. Custodial costs are comprised of interest retained by our HSA members, in respect of HSA cash with yield, and fees we pay to banking consultants whom we use to help secure agreements with our Depository -27- -------------------------------------------------------------------------------- Table of Contents Partners. Interest retained by HSA members is calculated on a tiered basis. The interest rates retained by HSA members can change based on a formula or upon required notice. Interchange costs. Interchange costs are comprised of costs we incur in connection with processing payment transactions initiated by our members. Due to the substantiation requirement on FSA/HRA-linked payment card transactions, payment card costs are higher for FSA/HRA card transactions. In addition to fixed per card fees, we are assessed additional transaction costs determined by the amount of the transaction. Gross profit and gross margin Our gross profit is our total revenue minus our total cost of revenue, and our gross margin is our gross profit expressed as a percentage of our total revenue. Our gross margin has been and will continue to be affected by a number of factors, including interest rates, the amount we charge ourNetwork Partners , Clients, and members, the mix of our sources of revenue, how many services we deliver per account, and payment processing costs per account. Operating expenses Sales and marketing. Sales and marketing expenses consist primarily of personnel and related expenses for our sales and marketing staff, including sales commissions for our direct sales force, external agent/broker commission expenses, marketing expenses, depreciation, amortization, stock-based compensation, and common expense allocations. Technology and development. Technology and development expenses include personnel and related expenses for software development and delivery, information technology, data management, product, and security. Technology and development expenses also include software engineering services, the costs of operating our on-demand technology infrastructure, depreciation, amortization of capitalized software development costs, stock-based compensation, and common expense allocations. General and administrative. General and administrative expenses include personnel and related expenses of, and professional fees incurred by our executive, finance, legal, internal audit, corporate development, compliance, and people departments. They also include depreciation, amortization, stock-based compensation, and common expense allocations. Amortization of acquired intangible assets. Amortization of acquired intangible assets results primarily from intangible assets acquired in connection with business combinations. The assets include acquired customer relationships, acquired developed technology, and acquired trade names and trademarks, which we amortize over the assets' estimated useful lives, estimated to be 7-15 years, 2-5 years, and 3 years, respectively. We also acquired intangible HSA portfolios from third-party custodians. We amortize these assets over the assets' estimated useful life of 15 years. We evaluate our acquired intangible assets for impairment annually, or at a triggering event. Merger integration. Merger integration expenses include personnel and related expenses, including severance, professional fees, legal expenses, and facilities and technology expenses directly related to integration activities to merge operations as a result of acquisitions. Interest expense Interest expense consists of accrued interest expense and amortization of deferred financing costs associated with our long-term debt. Interest on our Term Loan Facility changes frequently due to variable interest rate terms, and as a result, our interest expense is expected to fluctuate based on changes in prevailing interest rates. Other income (expense), net Other income (expense), net, consists of acquisition costs, interest income earned on corporate cash and other miscellaneous income and expense. Income tax provision (benefit) We are subject to federal and state income taxes inthe United States based on aJanuary 31 fiscal year end. We use the asset and liability method to account for income taxes, under which current tax liabilities and assets are recognized for the estimated taxes payable or refundable on the tax returns for the current fiscal year. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, net operating loss carryforwards, and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. Valuation allowances are established when necessary to reduce net deferred tax assets to the -28- -------------------------------------------------------------------------------- Table of Contents amount expected to be realized. As ofOctober 31, 2021 , we have recorded an overall net deferred tax liability on our condensed consolidated balance sheet. Comparison of the three and nine months endedOctober 31, 2021 and 2020 Revenue The following table sets forth our revenue for the periods indicated: Three months ended October 31, Nine months ended October 31, (in thousands, except percentages) 2021 2020 $ Change % Change 2021 2020 $ Change % Change Service revenue$ 102,733 $ 104,562 $ (1,829) (2) %$ 314,449 $ 319,638 $ (5,189) (2) % Custodial revenue 49,006 48,544 462 1 % 144,760 142,352 2,408 2 % Interchange revenue 28,215 26,245 1,970 8 % 94,050 83,411 10,639 13 % Total revenue$ 179,954 $ 179,351 $ 603 0 %$ 553,259 $ 545,401 $ 7,858 1 % Service revenue. The$1.8 million , or 2%, decrease in service revenue from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 was primarily due to a decrease in CDB accounts due to the COVID-19 pandemic and efforts to simplify our CDB administrative engagements on our go-forward platform, partially offset by new revenue from the Luum Acquisition. The$5.2 million , or 2%, decrease in service revenue from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 was primarily due to a decrease in CDB accounts due to the COVID-19 pandemic and efforts to simplify our CDB administrative engagements on our go-forward platform, partially offset by new revenue from the Luum Acquisition and an increase in revenue related to COBRA benefits administration. Custodial revenue. The$0.5 million , or 1%, increase in custodial revenue from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 was primarily due to the$1.4 billion , or 16%, increase in the year-over-year average daily balance of HSA cash with yield. The increase was partially offset by a decrease in average annualized yield from 2.08% for the three months endedOctober 31, 2020 to 1.72% for the three months endedOctober 31, 2021 , which was due in part to the interest rate cuts made by theFederal Reserve in response to the COVID-19 pandemic, and by increased transfers from HSA cash to HSA investments. The$2.4 million , or 2%, increase in custodial revenue from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 was primarily due to the$1.5 billion , or 18%, increase in the year-over-year average daily balance of HSA cash with yield. The increase was partially offset by a decrease in average annualized yield from 2.10% for the nine months endedOctober 31, 2020 to 1.76% for the nine months endedOctober 31, 2021 , which was due in part to the interest rate cuts made by theFederal Reserve in response to the COVID-19 pandemic, and by increased transfers from HSA cash to HSA investments. We are continuing to transition HSA cash without yield to HSA cash with yield and expect to complete the transition in fiscal year 2022. This cash is being placed with ourDepository Partners at prevailing interest rates, which we expect will generate additional custodial revenue. Interchange revenue. The$2.0 million , or 8%, increase in interchange revenue from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 was primarily due to increased spend per account and an increase in accounts. The$10.6 million , or 13%, increase in interchange revenue from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 was primarily due to increased spend per account and an increase in accounts. Total revenue. Total revenue increased$0.6 million , or less than one percent, from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 due to the increases in custodial and interchange revenues, largely offset by the decrease in service revenue. Total revenue increased$7.9 million , or 1%, from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 due to the increases in custodial and interchange revenues, partially offset by the decrease in service revenue. Impact of COVID-19. Our business has been adversely affected by the COVID-19 pandemic, and we expect that it will continue to be adversely affected by the COVID-19 pandemic, including as a result of the associated interest -29- -------------------------------------------------------------------------------- Table of Contents rate cuts by theFederal Reserve and other market conditions that have caused interest rates to decline significantly, which reduces the yield on funds placed with ourDepository Partners and insurance company partners in this environment. Sales opportunities have also been impacted, with some opportunities delayed and most now being held virtually. Our financial results related to certain of our products have also been adversely affected, such as commuter benefits, due to many of our members working from home during the outbreak and other impacts from the outbreak, and the "work from home" trend may continue after the pandemic. In particular, the recent increased spread of COVID-19 and the associated decisions by employers to delay return-to-office plans for their employees will further delay the recovery of use of these commuter benefits. During the initial stages of the COVID-19 pandemic, we saw a negative impact on our members' spend on healthcare, which negatively impacted both our interchange revenue and service revenue, and the current increase in COVID-19 cases has negatively impacted our interchange revenue and service revenue. In addition, we are required to support our Clients' open enrollment activities virtually. We may be unable to meet our service level commitments to our Clients as a result of disruptions to our work force and disruptions to third-party contracts that we rely on to provide our services. The extent to which the COVID-19 pandemic will continue to negatively impact our business remains highly uncertain and as a result may have a material adverse impact on our business and financial results. Cost of revenue The following table sets forth our cost of revenue for the periods indicated: Three months ended October 31, Nine months ended October 31, (in thousands, except percentages) 2021 2020 $ Change % Change 2021 2020 $ Change % Change Service costs$ 66,217 $ 65,936 $ 281 - %$ 204,183 $ 202,195 $ 1,988 1 % Custodial costs 5,734 4,762 972 20 % 15,567 14,805 762 5 % Interchange costs 4,683 4,095 588 14 % 15,102 13,985 1,117 8 %
Total cost of revenue
2 %$ 234,852 $ 230,985 $ 3,867 2 % Service costs. The$0.3 million , or less than one percent, increase in service costs from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 reflects a similar increase in total revenue from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 . The$2.0 million , or 1%, increase in service costs from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 reflects a similar increase in total revenue from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 . Custodial costs. The$1.0 million , or 20%, increase in custodial costs from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 was due to an increase in the average daily balance of HSA cash with yield, which increased from$8.7 billion for the three months endedOctober 31, 2020 to$10.1 billion for the three months endedOctober 31, 2021 and an associated increase in interest retained by HSA members, partially offset by a lower average annualized rate of interest retained by HSA members on HSA cash with yield, which decreased from 0.18% for the three months endedOctober 31, 2020 to 0.17% for the three months endedOctober 31, 2021 . The$0.8 million , or 5%, increase in custodial costs from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 was due to an increase in the average daily balance of HSA cash with yield, which increased from$8.4 billion for the nine months endedOctober 31, 2020 to$9.9 billion for the nine months endedOctober 31, 2021 and an associated increase in interest retained by HSA members, partially offset by a lower average annualized rate of interest retained by HSA members on HSA cash with yield, which decreased from 0.20% for the nine months endedOctober 31, 2020 to 0.17% for the nine months endedOctober 31, 2021 . Interchange costs. The$0.6 million , or 14%, increase in interchange costs from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 was due to increased spend per account and an increase in accounts. The$1.1 million , or 8%, increase in interchange costs from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 was due to increased spend per account and an increase in accounts. Total cost of revenue. As we continue to add Total Accounts, we expect that our cost of revenue will increase in dollar amount to support ourNetwork Partners , Clients, and members. Cost of revenue will continue to be affected by a number of different factors, including our ability to scale our service delivery, Network Partner implementation, account management functions, realized synergies, and the impact of the COVID-19 pandemic. We expect our cost -30- -------------------------------------------------------------------------------- Table of Contents of revenue to increase as a percentage of our total revenue, primarily due to the Further acquisition and stock-based compensation. Operating expenses The following table sets forth our operating expenses for the periods indicated: Three months ended October 31, Nine months ended October 31, (in thousands, except percentages) 2021 2020 $ Change % Change 2021 2020 $ Change % Change
Sales and marketing
(1) %$ 42,288 $ 36,502 $ 5,786 16 % Technology and development 38,070 30,758 7,312 24 % 111,437 92,490 18,947 20 % General and administrative 20,004 22,099 (2,095) (9) % 63,503 61,590 1,913 3 % Amortization of acquired intangible assets 19,642 19,126 516 3 % 59,745 56,905 2,840 5 % Merger integration 13,244 8,193 5,051 62 % 38,422 31,328 7,094 23 %
Total operating expenses
11 %$ 315,395 $ 278,815 $ 36,580 13 % Sales and marketing. Sales and marketing expense decreased by$0.2 million , or 1%, from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 . The$5.8 million , or 16%, increase in sales and marketing expense from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 was primarily due to an increase in marketing expenses from increased staffing and marketing collateral and increases in team member and partner commissions. We expect our sales and marketing expenses to increase for the foreseeable future as we focus on our cross-selling program and marketing campaigns. On an annual basis, we expect our sales and marketing expenses to continue to increase as a percentage of our total revenue. However, our sales and marketing expenses may fluctuate as a percentage of our total revenue from period to period due to the seasonality of our total revenue and the timing and extent of our sales and marketing expenses. We expect our sales and marketing expenses to increase as a percentage of our total revenue, primarily due to the Further acquisition and stock-based compensation. Technology and development. The$7.3 million , or 24%, increase in technology and development expense from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 was primarily due to increases in amortization, stock-based compensation, and personnel-related expenses. The$18.9 million , or 20%, increase in technology and development expense from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 was primarily due to increases in amortization, stock-based compensation, and personnel-related expenses. We expect our technology and development expenses to increase for the foreseeable future as we continue to invest in the development and security of our proprietary technology. On an annual basis, we expect our technology and development expenses to continue to increase as a percentage of our total revenue pursuant to our growth initiatives. Our technology and development expenses may fluctuate as a percentage of our total revenue from period to period due to the seasonality of our total revenue and the timing and extent of our technology and development expenses. We expect our technology and development expenses to increase as a percentage of our total revenue, primarily due to the Further acquisition and stock-based compensation. General and administrative. The$2.1 million , or 9%, decrease in general and administrative expense from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 was primarily due to temporary decreases in personnel-related expenses and professional fees. The$1.9 million , or 3%, increase in general and administrative expense from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 was primarily due to increases in credit losses on trade receivables and stock-based compensation, partially offset by decreases in personnel-related expenses and professional fees. We expect our general and administrative expenses to continue to increase for the foreseeable future due to the additional demands on our legal, compliance, accounting, and insurance functions that we incur as we continue to grow our business. On an annual basis, we expect our general and administrative expenses to increase as a percentage of our total revenue over the near term pursuant to our growth initiatives. Our general and administrative expenses may fluctuate as a percentage of our total revenue from period to period due to the seasonality of our -31- -------------------------------------------------------------------------------- Table of Contents total revenue and the timing and extent of our general and administrative expenses. We expect our technology and development expenses to increase as a percentage of our total revenue, primarily due to the Further acquisition and stock-based compensation. Amortization of acquired intangible assets. The$0.5 million , or 3%, increase in amortization of acquired intangible assets from the three months endedOctober 31, 2020 to the three months endedOctober 31, 2021 was primarily due to the inclusion of amortization related to identified intangible assets acquired through the Luum Acquisition. The remainder of the increase was due to amortization of the Fifth Third Bank HSA portfolio and other acquired HSA portfolios. The$2.8 million , or 5%, increase in amortization of acquired intangible assets from the nine months endedOctober 31, 2020 to the nine months endedOctober 31, 2021 was primarily due to the inclusion of amortization related to identified intangible assets acquired through the Luum Acquisition commencingMarch 8, 2021 . The remainder of the increase was due to amortization of acquired HSA portfolios. Merger integration. The$13.2 million and$38.4 million in merger integration expense for the three and nine months endedOctober 31, 2021 , respectively, was primarily due to personnel and related expenses, including expenses incurred in conjunction with the migration of accounts, severance, professional fees, technology-related, and facilities expenses directly related to theWageWorks Acquisition and additional integration expenses incurred related to the acquisition of Further. We expect integration expenses totaling approximately$110 million and$55 million in the aggregate for theWageWorks and Further acquisitions, respectively. Merger integration expenses attributable to the WageWorks Acquisition are expected to be completed by the end of fiscal year 2022, with the exception of ongoing lease expense related to certainWageWorks offices that have been permanently closed, less any related sublease income. As ofOctober 31, 2021 , we had incurred a total of approximately$117 million of non-recurring merger integration costs related to the WageWorks Acquisition and the Further acquisition. Interest expense The$11.9 million and$25.8 million in interest expense for the three and nine months endedOctober 31, 2021 , respectively, consisted primarily of interest accrued on our long-term debt and amortization of debt discount and issuance costs, as well as a$4.0 million loss on extinguishment of debt recorded during the three months endedOctober 31, 2021 as a result of the refinancing of our prior credit facility. We expect interest expense to increase, primarily as a result of the interest expense we will incur on the$600.0 million aggregate principal amount of the Notes issued during the quarter. Other income (expense), net The$3.5 million change in other income (expense), net, from expense of$0.4 million during the three months endedOctober 31, 2020 to income of$3.1 million during the three months endedOctober 31, 2021 was due to a$3.2 million gain resulting from a change in the fair value of contingent acquisition consideration from the Luum Acquisition and a$0.3 million increase in net other income. The$1.8 million decrease in other expense, net, from$2.0 million during the nine months endedOctober 31, 2020 to$0.2 million during the nine months endedOctober 31, 2021 was due to a$1.7 million gain on the sale of equity securities, a$0.6 million increase in interest income, and a$4.4 million increase in net other income, partially offset by a$4.9 million increase in net acquisition costs, which includes a$2.1 million gain resulting from a change in the fair value of contingent acquisition consideration from the Luum Acquisition. Income tax benefit Income tax benefit for the three and nine months endedOctober 31, 2021 was$4.1 million and$11.5 million , respectively, compared to income tax expense of$2.3 million and$2.0 million for the three and nine months endedOctober 31, 2020 , respectively. The$6.4 million and$13.5 million increase in the income tax benefit for the three and nine months endedOctober 31, 2021 compared to the three and nine months endedOctober 31, 2020 was primarily due to a decrease in pre-tax book income and an increase in excess tax benefits on stock-based compensation expense recognized in the provision for income taxes. Seasonality Seasonal concentration of our growth combined with our recurring revenue model create seasonal variation in our results of operations. Revenue results are seasonally impacted due to ancillary service fees, timing of HSA contributions, and timing of card spend. Cost of revenue is seasonally impacted as a significant number of new and existingNetwork Partners bring us new HSAs and CDBs beginning in January of each year concurrent with the start of many employers' benefit plan years. Before we realize any revenue from these new accounts, we incur costs related to implementing and supporting our newNetwork Partners and new accounts. These costs of services relate -32- -------------------------------------------------------------------------------- Table of Contents to activating accounts and hiring additional staff, including seasonal help to support our member support center. These expenses begin to ramp up during our third fiscal quarter, with the majority of expenses incurred in our fourth fiscal quarter. Liquidity and capital resources Cash and cash equivalents overview Our principal sources of liquidity are our current cash and cash equivalents balances, collections from our service, custodial, and interchange revenue activities, and availability under our Revolving Credit Facility (as defined below). We rely on cash provided by operating activities to meet our short-term liquidity requirements, which primarily relate to the payment of corporate payroll and other operating costs, payments under our Term Loan Facility, and capital expenditures. As ofOctober 31, 2021 andJanuary 31, 2021 , cash and cash equivalents were$649.1 million and$328.8 million , respectively. Cash and cash equivalents as ofOctober 31, 2021 included$456.6 million of net proceeds we received from our follow-on public offering in the first quarter of fiscal year 2022 from the sale of 5,750,000 shares of our common stock, partially offset by$50.2 million used for the Luum Acquisition, and an additional$60.8 million used to acquire the Fifth Third Bank HSA portfolio. Subsequent toOctober 31, 2021 , the Company used the remaining net proceeds from the offering, and other cash on hand, for the acquisition of Further. Capital resources We maintain a "shelf" registration statement on Form S-3 on file with theSEC . A shelf registration statement, which includes a base prospectus, allows us at any time to offer any combination of securities described in the prospectus in one or more offerings. Unless otherwise specified in a prospectus supplement accompanying the base prospectus, we would use the net proceeds from the sale of any securities offered pursuant to the shelf registration statement for general corporate purposes, including, but not limited to, working capital, sales and marketing activities, general and administrative matters, capital expenditures, and repayment of indebtedness, and if opportunities arise, for the acquisition of, or investment in, assets, technologies, solutions or businesses that complement our business. Pending such uses, we may invest the net proceeds in interest-bearing securities. In addition, we may conduct concurrent or other financings at any time. In the first quarter of fiscal year 2022, we closed a follow-on public offering of 5,750,000 shares of common stock at a public offering price of$80.30 per share, less the underwriters' discount. We received net proceeds of$456.6 million after deducting underwriting discounts and commissions of$4.6 million and other offering expenses of approximately$0.5 million . OnOctober 8, 2021 , the Company completed its offering of$600.0 million aggregate principal amount of its 4.50% Senior Notes due 2029. In addition, onOctober 8, 2021 , the Company entered into a Credit Agreement (the "Credit Agreement") which includes a five-year senior secured term loan A facility, in an aggregate principal amount of$350.0 million , and a five-year senior secured revolving credit facility (the "Revolving Credit Facility"), in an aggregate principal amount of up to$1.0 billion , which may be used for working capital and general corporate purposes, including the financing of acquisitions and other investments. The net proceeds from the issuance of the Notes together with borrowings under the Credit Agreement and$31.8 million of cash on hand, were used to repay the outstanding borrowings under the prior credit agreement, datedAugust 20, 2019 . For a description of the terms of the Credit Agreement, refer to Note 8-Indebtedness. As ofOctober 31, 2021 , there were no amounts outstanding under the Revolving Credit Facility. We were in compliance with all covenants under the Credit Agreement as ofOctober 31, 2021 , and for the period then ended. Use of cash We used$50.2 million of the net proceeds from the follow-on public offering for the Luum Acquisition and used an additional$60.8 million to acquire the Fifth Third Bank HSA portfolio. Subsequent toOctober 31, 2021 , the Company used the remaining net proceeds from the offering, and other cash on hand, for the acquisition of Further. Capital expenditures for the nine months endedOctober 31, 2021 and 2020 were$56.3 million and$48.6 million , respectively. We expect to continue our current level of increased capital expenditures for the remainder of the fiscal year endingJanuary 31, 2022 as we continue to devote a significant amount of our capital expenditures to improving the architecture and functionality of our proprietary systems. Costs to improve the architecture of our proprietary systems include computer hardware, personnel and related costs for software engineering and outsourced software engineering services. -33- -------------------------------------------------------------------------------- Table of Contents We believe our existing cash, cash equivalents, and Revolving Credit Facility will be sufficient to meet our operating and capital expenditure requirements for at least the next 12 months. To the extent these current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, we may need to raise additional funds through public or private equity or debt financing. In the event that additional financing is required, we may not be able to raise it on favorable terms, if at all. The following table shows our cash flows from operating activities, investing activities, and financing activities for the stated periods: Nine months ended October 31, (in thousands) 2021
2020
Net cash provided by operating activities$ 90,438 $ 120,717 Net cash used in investing activities (167,946)
(76,730)
Net cash provided by financing activities 397,834
63,643
Increase in cash and cash equivalents 320,326
107,630
Beginning cash and cash equivalents 328,803
191,726
Ending cash and cash equivalents$ 649,129
Cash flows from operating activities. Net cash provided by operating activities during the nine months endedOctober 31, 2021 resulted from net loss of$11.5 million , plus depreciation and amortization expense of$98.4 million , stock-based compensation expense of$41.7 million , amortization of debt discount and issuance costs of$3.6 million , and a loss on extinguishment of debt of$4.0 million , partially offset by a decrease in the fair value of contingent consideration of$2.1 million and other non-cash items and working capital changes totaling$43.7 million . Net cash provided by operating activities during the nine months endedOctober 31, 2020 resulted from net income of$3.5 million , plus depreciation and amortization expense of$85.5 million , stock-based compensation expense of$30.3 million , and amortization of debt discount and issuance costs of$3.8 million , partially offset by other non-cash items and working capital changes totaling$2.4 million . Cash flows from investing activities. Cash used in investing activities for the nine months endedOctober 31, 2021 resulted from the Luum Acquisition for$49.5 million , net of cash acquired,$49.0 million in software and capitalized software development,$7.3 million in purchases of property and equipment, and$64.5 million in acquisitions of intangible member assets, partially offset by$2.4 million of proceeds from the sale of equity securities associated with a long-term capital investment. Net cash used in investing activities for the nine months endedOctober 31, 2020 resulted from$37.2 million in software and capitalized software development,$11.4 million in purchases of property and equipment, and$28.1 million in acquisitions of intangible member assets. Cash flows from financing activities. Net cash provided by financing activities during the nine months endedOctober 31, 2021 resulted from$938.2 million of net proceeds from the issuance of long-term debt,$456.6 million of net proceeds from our follow-on public offering of 5,750,000 shares of common stock, and the exercise of stock options of$7.7 million . These items were partially offset by$1.0 billion of principal payments on our long-term debt and$1.6 million used in the settlement of Client-held funds obligations. Net cash provided by financing activities during the nine months endedOctober 31, 2020 resulted primarily from$286.8 million of net proceeds from our follow-on public offering of 5,290,000 shares of common stock and the exercise of stock options of$4.5 million , partially offset by$223.4 million of principal payments on our long-term debt and$4.2 million used in the settlement of Client-held funds obligations. Contractual obligations See Note 6-Commitments and contingencies for information about our contractual obligations. -34- -------------------------------------------------------------------------------- Table of Contents Off-balance sheet arrangements As ofOctober 31, 2021 , other than outstanding letters of credit issued under our Revolving Credit Facility, we did not have any off-balance sheet arrangements. The majority of the standby letters of credit expire within one year. However, in the ordinary course of business, we will continue to renew or modify the terms of the letters of credit to support business requirements. The letters of credit are contingent liabilities, supported by our Revolving Credit Facility, and are not reflected on our condensed consolidated balance sheets. Critical accounting policies and significant management estimates Our management's discussion and analysis of financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these unaudited condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions. Our significant accounting policies are more fully described in Note 1 of the accompanying unaudited condensed consolidated financial statements and in Note 1 to our audited consolidated financial statements contained in our Annual Report on Form 10-K for the fiscal year endedJanuary 31, 2021 . There have been no significant or material changes in our critical accounting policies during the nine months endedOctober 31, 2021 , as compared to those disclosed in "Management's discussion and analysis of financial condition and results of operations - Critical accounting policies and significant management estimates" in our Annual Report on Form 10-K for the fiscal year endedJanuary 31, 2021 . Recent accounting pronouncements See Note 1-Summary of business and significant accounting policies within the interim financial statements included in this Form 10-Q for further discussion. Item 3. Qualitative and quantitative disclosures about market risk Market risk Concentration of market risk. We derive a substantial portion of our revenue from providing services to tax-advantaged healthcare account holders. A significant downturn in this market or changes in state and/or federal laws impacting the preferential tax treatment of healthcare accounts such as HSAs could have a material adverse effect on our results of operations. During the nine months endedOctober 31, 2021 and 2020, no one customer accounted for greater than 10% of our total revenue. We monitor market and regulatory changes regularly and make adjustments to our business if necessary. Inflation. Inflationary factors may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of expenses as a percentage of revenue if our revenue does not correspondingly increase with inflation. Concentration of credit risk Financial instruments, which potentially subject us to concentrations of credit risk, consist primarily of cash and cash equivalents. We maintain our cash and cash equivalents in bank and other depository accounts, which frequently may exceed federally insured limits. Our cash and cash equivalents as ofOctober 31, 2021 were$649.1 million , the vast majority of which was not covered by federal depository insurance. We have not experienced any material losses in such accounts and believe we are not exposed to any significant credit risk with respect to our cash and cash equivalents. Our accounts receivable balance as ofOctober 31, 2021 was$84.1 million . We have not experienced any significant write-offs to our accounts receivable and believe that we are not exposed to significant credit risk with respect to our accounts receivable; however, the extent to which the ongoing COVID-19 pandemic will negatively impact our credit risk remains highly uncertain and cannot be accurately predicted. We continue to monitor our credit risk and place our cash and cash equivalents with reputable financial institutions. -35- -------------------------------------------------------------------------------- Table of Contents Interest rate risk HSA Assets and Client-held funds. HSA Assets consist of custodial HSA funds we hold in custody on behalf of our members. As ofOctober 31, 2021 , we held in custody HSA Assets of approximately$16.4 billion . As a non-bank custodian, we contract with ourDepository Partners and insurance company partners to hold custodial cash assets on behalf of our members, and we earn a significant portion of our total revenue from interest paid to us by these partners. Custodial cash assets held by our insurance company partners are held in group annuity contracts and similar arrangements. The lengths of our agreements withDepository Partners typically range from three to five years and have either fixed or variable interest rates. As HSA Assets increase and existing contracts withDepository Partners expire, we seek to enter into new contracts withDepository Partners , the terms of which are impacted by the then-prevailing interest rate environment. The diversification of HSA Assets placed among ourDepository Partners and insurance company partners, and varied contract terms, substantially reduces our exposure to short-term fluctuations in prevailing interest rates and mitigates the short-term impact of a sustained increase or decline in prevailing interest rates on our custodial revenue. A sustained decline in prevailing interest rates may negatively affect our business by reducing the size of the interest rate yield, or yield, available to us and thus the amount of the custodial revenue we can realize. Conversely, a sustained increase in prevailing interest rates can increase our yield. An increase in our yield would increase our custodial revenue as a percentage of total revenue. In addition, if our yield increases, we expect the spread to also increase between the interest offered to us by ourDepository Partners and insurance company partners and the interest retained by our members, thus increasing our profitability. However, we may be required to increase the interest retained by our members in a rising prevailing interest rate environment. Changes in prevailing interest rates are driven by macroeconomic trends and government policies over which we have no control, such as the interest rate cuts by theFederal Reserve associated with the ongoing COVID-19 pandemic. Client-held funds are interest earning deposits from which we generate custodial revenue. As ofOctober 31, 2021 , we held Client-held funds of approximately$811.0 million . These deposits are amounts remitted by Clients and held by us on their behalf to pre-fund and facilitate administration of our other CDBs. These deposits are held withDepository Partners . We deposit the Client-held funds with ourDepository Partners in interest-bearing, demand deposit accounts that have a floating interest rate and no set term or duration. A sustained decline in prevailing interest rates may negatively affect our business by reducing the size of the yield available to us and thus the amount of the custodial revenue we can realize from Client-held funds. Changes in prevailing interest rates are driven by macroeconomic trends and government policies over which we have no control. Cash and cash equivalents. We consider all highly liquid investments purchased with an original maturity of three months or less to be unrestricted cash equivalents. Our unrestricted cash and cash equivalents are held in institutions in theU.S. and include deposits in a money market account that is unrestricted as to withdrawal or use. As ofOctober 31, 2021 , we had unrestricted cash and cash equivalents of$649.1 million . Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our cash and cash equivalents as a result of changes in interest rates. Long-term debt. As ofOctober 31, 2021 , we had$350.0 million outstanding under our Term Loan Facility and no amounts drawn under our Revolving Credit Facility. Our overall interest rate sensitivity under these credit facilities is primarily influenced by any amounts borrowed and the prevailing interest rates on these instruments. The interest rate on our term loan credit facility and Revolving Credit Facility is variable and was 1.88% atOctober 31, 2021 . Accordingly, we may incur additional expense if interest rates increase in future periods. For example, a one percent increase in the interest rate on the amount outstanding under our credit facilities atOctober 31, 2021 would result in approximately$3.5 million of additional interest expense over the next 12 months. The interest rate on our Notes is fixed at 4.50%. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures Management, with the participation of the Company's Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), has evaluated the effectiveness of the Company's disclosure controls and procedures as ofOctober 31, 2021 , the end of the period covered by this Quarterly Report on Form 10-Q. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to provide reasonable assurance that the information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in theSEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to provide reasonable assurance that the -36- -------------------------------------------------------------------------------- Table of Contents information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on such evaluation, the CEO and CFO have concluded that as ofOctober 31, 2021 , the Company's disclosure controls and procedures were not effective because of the material weaknesses in internal control over financial reporting described below. Notwithstanding the ineffective disclosure controls and procedures as a result of the identified material weaknesses described below, management has concluded that the condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q present fairly, in all material respects, the Company's financial position, results of operations and cash flows in accordance with generally accepted accounting principles inthe United States of America . In accordance with interpretive guidance issued bySEC staff, companies are allowed to exclude acquired businesses from the assessment of internal control over financial reporting during the first year after completion of an acquisition and from the assessment of disclosure controls and procedures to the extent subsumed in such internal control over financial reporting. In accordance with this guidance, as the Company acquired Luum onMarch 8, 2021 , management's evaluation and conclusion as to the effectiveness of the Company's disclosure controls and procedures as ofOctober 31, 2021 excluded the portion of disclosure controls and procedures that are subsumed by internal control over financial reporting of Luum. Luum's assets and revenues represented approximately 1%, excluding the effects of purchase accounting, of the Company's consolidated total assets and consolidated total revenues as of and for the fiscal quarter endedOctober 31, 2021 . Material Weaknesses in Internal Control over Financial Reporting Management identified certain deficiencies inWageWorks' internal control over financial reporting that aggregated to material weaknesses in the following components of the Internal Control - Integrated Framework (2013) issued by theCommittee of Sponsoring Organizations of theTreadway Commission ("COSO Framework"): Risk Assessment - TheWageWorks subsidiary did not sufficiently identify and analyze risks arising from changes in the business environment, including risks arising in connection with the integration of acquisitions and financial system implementations. Information and Communication - TheWageWorks subsidiary did not establish cross-functional procedures and policies relating to effective information and communication necessary to support the functioning of internal control over financial reporting. Monitoring - TheWageWorks subsidiary did not implement effective monitoring controls that were responsive to changes in the business or the timely remediation of identified control deficiencies. The COSO Framework component material weaknesses described above contributed to deficiencies at the control activity level that aggregated to the material weaknesses described below: A. Accounting Close and Financial Reporting TheWageWorks subsidiary had inadequate process level and monitoring controls in the area of accounting close and financial reporting specifically, but not exclusively, around the review of account reconciliations, completeness and accuracy of data material to financial reporting, accounting estimates and related cut-off, the establishment, review, and implementation of accounting policies, and the review of the accuracy and completeness of certain manual and complex data feeds into journal entries and reconciliations of high-volume standard transactions. B. Contract to Cash Process The Company did not have effective controls around the contract-to-cash life cycle of service fees, including ineffective process level controls around billing set-up during customer implementation, managing change to existing customer billing terms and conditions, timely termination of customers, implementing complex and/or non-standard billing arrangements that require manual intervention or manual controls for billing to customers, processing timely adjustments, lack of robust, established and documented policies to assess collectability and reserve for revenue, bad debts and accounts receivable, availability of customer contracts, and reviews of non-standard contracts. -37- -------------------------------------------------------------------------------- Table of Contents C. Information Technology General Controls The Company did not have effective controls related to information technology general controls (ITGCs) in the areas of logical access and change-management over certain information technology systems that supported its financial reporting processes. The Company's business process controls (automated and manual) that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted. These material weaknesses resulted in material misstatements ofWageWorks' historical financial statements, which preceded the acquisition, and could result in a misstatement of our account balances or disclosures that would result in a material misstatement to the annual or interim condensed consolidated financial statements that would not be prevented or detected. Ongoing Integration and Remediation Efforts Management has assessed the impact of the acquisition ofWageWorks on the Company's internal control over financial reporting and continues to assess changes driven by the integration ofWageWorks with the existing operations at the consolidated Company. As part of this assessment, management has continued to evaluate the Company's internal control environment to ensure that it has appropriate controls in place to mitigate the risks of a material misstatement to its consolidated financial statements associated with theWageWorks subsidiary and the Company as a whole. In response to the COSO Framework component material weaknesses in theWageWorks subsidiary's internal control over financial reporting, management has taken the following actions: •performed its recurring risk assessment and scoping of key systems and business processes, including a risk assessment at the financial statement assertion level to ensure that the level of precision of relevant controls is adequate to address the identified risks; •dedicated certain senior finance, accounting, operational, and IT leadership team members to work on remediation efforts and appointed third-party internal controls advisors to assist with such efforts; •implemented a periodic assessment to monitor business changes impacting accounting processes and controls; •incorporated certainWageWorks processes into the Company's existing entity-level controls; •established periodic reporting of the remediation plan progress to theAudit and Risk Committee of the Company's board of directors; •formalized documentation underlying processes and controls to promote knowledge and information transfer across functions and upon personnel changes; and •continued to monitor the operating effectiveness of the existing entity-level controls. Although we have implemented the remediation plans detailed above, certain of these controls have not yet operated in the current fiscal year for us to evaluate if the material weakness has been remediated. In response to the material weakness "A. Accounting Close and Financial Reporting," management has taken the following actions: •incorporated certainWageWorks processes into the Company's process-level controls, including, but not limited to, those that address the monitoring of the accounting close cycle and enhanced the evaluation of accounting policies; •redesigned certain processes and controls in conjunction with the enterprise resource planning "ERP" system migration described below; •formalized the assessment of the relevancy of information and data used in key controls, including a plan to design or augment controls to incorporate the review of the accuracy and completeness of such items; and •continued to monitor the operating effectiveness of the process-level and redesigned controls. Although we have implemented the remediation plan detailed above, these controls have not been in place and operating for a sufficient period of time for us to evaluate if the material weakness has been remediated. In response to the material weakness "B. Contract to Cash Process," management has taken the following actions: •continued to execute its plan to consolidate service platforms related to the contract-to-cash cycle, which will reduce a significant number of manual business process controls; •enhanced the design of existing controls including information and data used in controls, where applicable, and began implementing additional controls to further strengthen the control environment; and •implemented a process to assess the design and monitor the operating effectiveness of the redesigned controls. -38- -------------------------------------------------------------------------------- Table of Contents In response to the material weakness "C. Information Technology General Controls," management has taken the following actions: •continued to execute its plan to consolidate service platforms, which will reduce the number of ITGCs in the areas of logical access and change management; •enhanced the design of existing controls, where applicable, and implemented additional controls to further strengthen the control environment; and •implemented a process to assess and enhance the design and monitor the operating effectiveness of controls related to logical access and change management for relevant applications and systems. As we continue to evaluate operating effectiveness and monitor improvements to our internal control over financial reporting, we may take additional measures to address control deficiencies or modify the remediation plans described above. As part of our integration efforts, we have migrated all of our material operations to a single ERP system for the consolidated Company that will enhance our business and financial processes and standardize our information systems. We have re-assessed risks in response to the ERP system migration and the associated changes to underlying processes. We have redesigned certain controls in response to the current risks and continue to monitor the operating effectiveness of the redesigned controls. Changes in Internal Control Over Financial Reporting Other than continuing to make progress on the ongoing integration and remediation efforts described above, there were no changes in the Company's internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter endedOctober 31, 2021 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. -39-
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