HEALTHEQUITY : Management's discussion and analysis of financial condition and results of operations (form 10-Q)

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 close the acquisition of Further, the
impact of the ongoing COVID-19 pandemic on the Company, the anticipated
synergies and other benefits of the WageWorks acquisition, 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 ended January 31, 2021, this
Quarterly Report on Form 10-Q, and our other reports filed with the SEC.
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 of April 30, 2021, we administered 5.8 million HSAs, with balances
totaling $15.0 billion, which we call HSA Assets. Also, as of April 30, 2021, we
administered 7.0 million complementary CDBs. We refer to the aggregate number of
HSAs and other CDBs that we administer as Total Accounts, of which we had 12.8
million as of April 30, 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
call Network Partners.
We have increased our share of the growing HSA market from 4% in calendar year
2010 to 16% in 2020, measured by HSA Assets. According to Devenir, today we are
the largest HSA provider by accounts and second largest by assets. 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-driven culture. Our proprietary
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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
On August 30, 2019, we completed the acquisition of WageWorks, Inc. (the
"WageWorks Acquisition") and paid approximately $2.0 billion in cash to
WageWorks stockholders, financed through net borrowings of approximately $1.22
billion under a new 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 of HealthEquity, 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 through Network Partners. With WageWorks' 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 by Aite 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 $65 million were achieved
as of April 30, 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 $100 million incurred by the end of fiscal year
2022, 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. As of April 30, 2021, we had incurred
a total of approximately $87 million of non-recurring merger integration costs
related to the WageWorks Acquisition.
Luum Acquisition
In March 2021, we bolstered our commuter offering by acquiring 100% of the
outstanding capital stock of Fort 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. 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
In April 2021, we entered into a definitive agreement with Fifth Third Bank,
National Association ("Fifth Third"), to transition custodianship of Fifth
Third's HSA portfolio to HealthEquity. The definitive agreement contemplates a
$60.8 million dollar purchase price for a transfer of approximately 149,000 HSA
members and their approximately $477.0 million of HSA Assets. The agreement
includes a mechanism to adjust the purchase price based on the amount of HSA
Assets actually transferred. The transaction is subject to regulatory approval
and satisfaction of other customary closing conditions.

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Further Acquisition
In April 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 550,000 HSAs and $1.7 billion of HSA Assets. The
transaction is subject to regulatory approvals and other customary closing
conditions and is expected to close by September 2021.
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 ended January 31, 2021, this
Quarterly Report on Form 10-Q, and our other reports filed with the SEC.
Structural change in U.S. health insurance
We derive revenue primarily from healthcare-related saving and spending by
consumers in the U.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 2015 and 55% since
2010, 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 in U.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 in U.S. tax law
Tax law has a profound impact on our business. Our offerings to members,
Clients, and Network Partners consist primarily of services enabled, mandated,
or advantaged by provisions of U.S. tax law and regulations. We believe that the
present direction of U.S. tax policy is favorable to our business, as evidenced
for example by recent regulatory action and bipartisan policy proposals to
expand the availability of HSAs. However, 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
with Network 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 new Clients and
Network Partners. Our sales force calls on enterprise and regional employers in
industries across the U.S., as well as potential Network Partners from among
health plans, benefits administrators, and retirement plan record keepers.
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 by Aite Group. We believe that
the combination of HSA and complementary CDB offerings significantly strengthens
our value proposition to employers, health benefits brokers and consultants, and
Network 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 are building on these innovations by
combining our HSA offering with WageWorks' complementary CDB offerings, giving
us a full suite of CDB products, and adding to our solutions set
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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 our Depository 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. The lengths of our agreements with Depository Partners
typically range from three to five years and may have fixed or variable interest
rate terms. The terms of new and renewing agreements 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 of
Depository 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, we expect our custodial revenue to
continue to be adversely affected by the interest rate cuts by the Federal
Reserve associated with the ongoing COVID-19 pandemic, the lack of demand from
Depository Partners for deposits, and other market conditions that have caused
the interest rates offered by our Depository Partners to decline significantly.
Interest on our long-term debt 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 as United
Health Group's Optum, Webster Bank, and well-known retail investment companies,
such as Fidelity Investments) are in a position to 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. Our Network 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. As an increasing number of companies go out of business, the number
of our Clients and potential Clients is adversely affected. Increased
unemployment may mean that fewer of our members contribute to HSAs, FSAs, or
other CDBs and reduce overall demand for our products. 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.


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Regulatory environment
Federal law and regulations, including the Affordable Care Act, the Internal
Revenue Code, the Employee 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, the USA 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
subsidiary HealthEquity Trust Company is regulated by the Wyoming 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, including California, which in 2018
enacted the California Consumer Privacy Act broadly regulating California
residents' personal information and providing California 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.
On March 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.
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)               April 30, 2021             April 30, 2020                 % Change              January 31, 2021
HSAs                                               5,846                      5,380                            9  %                 5,782
New HSAs from sales - Quarter-to-date                115                        104                           11  %                   370
New HSAs from sales - Year-to-date                   115                        104                           11  %                   687
New HSAs from acquisitions - Year-to-date              -                          -                             n/a                     -
HSAs with investments                                371                        245                           51  %                   333
CDBs                                               6,986                      7,338                           (5) %                 7,028
Total Accounts                                    12,832                     12,718                            1  %                12,810
Average Total Accounts - Quarter-to-date          12,870                     12,784                            1  %                12,659
Average Total Accounts - Year-to-date             12,870                     12,784                            1  %                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
0.5 million, or 9%, from April 30, 2020 to April 30, 2021, due to further
penetration into existing Network Partners and the addition of new Network
Partners. The number of
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our CDBs decreased by approximately 0.4 million, or 5%, from April 30, 2020 to
April 30, 2021, driven by a 0.7 million decrease in commuter benefit accounts
that are currently suspended due to the COVID-19 pandemic and fewer workers
being required to commute to an office, partially offset by an increase in COBRA
accounts. 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 our HSA Assets as of and for the periods
indicated:
(in millions, except percentages)             April 30, 2021          April 30, 2020                 % Change           January 31, 2021
HSA cash with yield (1)                    $        9,809          $        8,338                       18  %       $           9,875
HSA cash without yield (2)                            217                     386                      (44) %                     244
Total HSA cash                                     10,026                   8,724                       15  %                  10,119
HSA investments with yield (1)                      4,869                   2,483                       96  %                   4,078
HSA investments without yield (2)                     118                     297                      (60) %                     138
Total HSA investments                               4,987                   2,780                       79  %                   4,216
Total HSA Assets                                   15,013                  11,504                       31  %                  14,335
Average daily HSA cash with yield -
Year-to-date                                        9,826                   8,283                       19  %                   8,599
Average daily HSA cash with yield -
Quarter-to-date                            $        9,826          $        8,283                       19  %       $           9,060


(1)HSA Assets that generate custodial revenue.
(2)HSA Assets that do not generate custodial revenue.
Our 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) cash deposits, which are deposits with our Depository
Partners or other custodians, (ii) custodial cash deposits invested in annuity
contracts with our insurance company partners, and (iii) 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 our HSA Assets is important
because our custodial revenue is directly affected by average daily custodial
balances for HSA Assets that are revenue generating.
Total HSA cash increased by $1.3 billion, or 15%, from April 30, 2020 to
April 30, 2021, due primarily to HSA contributions, new HSAs, and decreased
spending per HSA, partially offset by transfers to HSA investments.
Our HSA investment assets increased by $2.2 billion, or 79%, from April 30, 2020
to April 30, 2021, due primarily to transfers from HSA cash and appreciation of
invested balances.
Our total HSA Assets increased by $3.5 billion, or 31%, from April 30, 2020 to
April 30, 2021, due primarily to HSA contributions, new HSAs, decreased spending
per HSA, and appreciation of invested balances.
Client-held funds
(in millions, except percentages)              April 30, 2021           April 30, 2020                 % Change           January 31, 2021
Client-held funds (1)                      $           903          $           894                        1  %       $             986
Average daily Client-held funds -
Year-to-date (1)                                       899                      831                        8  %                     847
Average daily Client-held funds -
Quarter-to-date (1)                                    899                      831                        8  %                     848


(1) Client-held funds that generate custodial revenue.
Our 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 our Depository 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 marketable 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
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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 April 30,
(in thousands)                                                         2021          2020
Net income (loss)                             $        (2,615)                 $  1,826
Interest income                                          (408)                     (600)
Interest expense                                        6,689                    12,263
Income tax provision (benefit)                         (3,451)              

218

Depreciation and amortization                          11,954               

8,805

Amortization of acquired intangible assets             19,814               

18,702

Stock-based compensation expense                       12,799                     7,396
Merger integration expenses                             8,807                    12,770
Acquisition costs (1)                                   5,939                        94
Other (2)                                                (554)                    1,535
Adjusted EBITDA                               $        58,974                  $ 63,009


(1)For the three months ended April 30, 2021, acquisition costs included $0.3
million of stock-based compensation.
(2)For the three months ended April 30, 2021, other consisted of amortization of
incremental costs to obtain a contract of $1.3 million offset by other income,
net, of $1.8 million. For the three months ended April 30, 2020, other consisted
of incremental costs to obtain a contract of $0.3 million and other costs of
$1.3 million.
The following table further sets forth our Adjusted EBITDA as a percentage of
revenue:
                                                 Three months ended April 

30,

(in thousands, except percentages)                    2021               2020           $ Change                  % Change
Adjusted EBITDA                          $      58,974           $  63,009          $  (4,035)                       (6) %
As a percentage of revenue                          32   %              33  %


Our Adjusted EBITDA decreased by $4.0 million, or 6%, from $63.0 million for the
three months ended April 30, 2020 to $59.0 million for the three months ended
April 30, 2021. The decrease in Adjusted EBITDA was primarily driven by a
decrease in revenue of $5.8 million, or 3%, as described below.
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 our Network
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 our HSA Assets
deposited with our Depository Partners and with our insurance company partners,
Client-held funds deposited with our Depository Partners, and recordkeeping fees
we earn in respect of mutual funds in which our members invest. We deposit HSA
cash with our Depository 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. We deposit the Client-held funds with our Depository 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 these Depository
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.
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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 our
Network 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 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 our Network 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.
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Interest expense
Interest expense consists of accrued interest expense and amortization of
deferred financing costs associated with our credit agreement. Interest on our
long-term debt 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 expense, net
Other expense, net, consists of acquisition costs, partially offset by 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 in the United States based on a
January 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 amount
expected to be realized. As of April 30, 2021, we have recorded an overall net
deferred tax liability on our condensed consolidated balance sheet.
Comparison of the three months ended April 30, 2021 and 2020
Revenue
The following table sets forth our revenue for the periods indicated:
                                                  Three months ended April 

30,

(in thousands, except percentages)                     2021               2020           $ Change                  % Change
Service revenue                          $       102,534          $ 111,271          $  (8,737)                       (8) %
Custodial revenue                                 46,978             46,899                 79                         -  %
Interchange revenue                               34,690             31,841              2,849                         9  %
Total revenue                            $       184,202          $ 190,011          $  (5,809)                       (3) %


Service revenue. The $8.7 million, or 8%, decrease in service revenue from the
three months ended April 30, 2020 to the three months ended April 30, 2021 was
primarily due to the 0.7 million decrease in the number of commuter benefit
accounts due to accounts being suspended as a result of the COVID-19 pandemic.
Custodial revenue. The $0.1 million, or less than 1%, increase in custodial
revenue from the three months ended April 30, 2020 to the three months ended
April 30, 2021 was primarily due to the $1.5 billion, or 19%, increase in the
year-over-year average daily balance of HSA cash with yield. The increase was
largely offset by a decrease in average annualized yield from 2.12% for the
three months ended April 30, 2020 to 1.79% for the three months ended April 30,
2021, which was due in part to the interest rate cuts made by the Federal
Reserve in response to the COVID-19 pandemic.
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 our Depository Partners at prevailing interest rates, which we
expect will generate additional custodial revenue.
Interchange revenue. The $2.8 million, or 9%, increase in interchange revenue
from the three months ended April 30, 2020 to the three months ended April 30,
2021 was primarily due to increased spend per HSA, partially offset by a
decrease in spend with respect to commuter benefit accounts partially
attributable to the COVID-19 pandemic and fewer workers being required to
commute to an office.
Total revenue. Total revenue decreased by $5.8 million, or 3%, from the three
months ended April 30, 2020 to the three months ended April 30, 2021, primarily
due to the decrease in service revenue associated with suspended commuter
benefit accounts, partially offset by an increase in interchange 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 rate cuts by
the Federal Reserve and other market conditions that have caused interest rates
to decline significantly,
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which reduces the yield on funds placed with our Depository Partners in this
environment. Sales opportunities have also been impacted, with some
opportunities delayed and most now being held virtually. In addition, we are
required to support our Clients' open enrollment activities virtually. As an
increasing number of companies go out of business, the number of our Clients and
potential Clients is adversely affected. Increased unemployment may mean that
fewer of our members contribute to HSAs, FSAs or other CDBs. 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. 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.
Clients may be unable to pay fees required under contracts and exercise "force
majeure" or similar defenses, which would negatively impact our financial
results. 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 April 

30,

(in thousands, except percentages)                     2021               2020            $ Change                  % Change
Service costs                            $        70,632          $  71,013          $     (381)                       (1) %
Custodial costs                                    5,009              5,045                 (36)                       (1) %
Interchange costs                                  5,445              5,879                (434)                       (7) %
Total cost of revenue                    $        81,086          $  81,937          $     (851)                       (1) %


Service costs. The $0.4 million, or 1%, decrease in service costs from the three
months ended April 30, 2020 to the three months ended April 30, 2021 was
primarily due to decreases in service costs related to commuter benefit
accounts.
Custodial costs. The $36,000, or 1%, decrease in custodial costs from the three
months ended April 30, 2020 to the three months ended April 30, 2021 was due to
a lower average annualized rate of interest retained by HSA members on HSA cash
with yield, which decreased from 0.21% for the three months ended April 30, 2020
to 0.18% for the three months ended April 30, 2021, largely offset by an
increase in the average daily balance of HSA cash with yield, which increased
from $8.3 billion for the three months ended April 30, 2020 to $9.8 billion for
the three months ended April 30, 2021.
Interchange costs. The $0.4 million, or 7%, decrease in interchange costs from
the three months ended April 30, 2020 to the three months ended April 30, 2021
was due to realized synergies attributable to the WageWorks Acquisition.
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 our Network 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.
Operating expenses
The following table sets forth our operating expenses for the periods indicated:
                                                   Three months ended April 

30,

(in thousands, except percentages)                      2021               2020            $ Change                  % Change
Sales and marketing                       $        14,086          $  11,455          $    2,631                        23  %
Technology and development                         35,469             31,078               4,391                        14  %
General and administrative                         20,687             18,998               1,689                         9  %
Amortization of acquired intangible
assets                                             19,814             18,702               1,112                         6  %
Merger integration                                  8,807             12,770              (3,963)                      (31) %
Total operating expenses                  $        98,863          $  93,003          $    5,860                         6  %


Sales and marketing. The $2.6 million, or 23%, increase in sales and marketing
expense from the three months ended April 30, 2020 to the three months ended
April 30, 2021 was primarily due to an increase in marketing expenses from
increased staffing and marketing collateral and increases in team member and
partner commissions.
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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 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.
Technology and development. The $4.4 million, or 14%, increase in technology and
development expense from the three months ended April 30, 2020 to the three
months ended April 30, 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 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.
General and administrative. The $1.7 million, or 9%, increase in general and
administrative expense from the three months ended April 30, 2020 to the three
months ended April 30, 2021 was primarily due to increases in stock-based
compensation, partially offset by decreases in personnel-related expenses.
We expect our general and administrative expenses 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 remain relatively steady 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 total revenue and the timing and extent of our general
and administrative expenses.
Amortization of acquired intangible assets. The $1.1 million increase in
amortization of acquired intangible assets from the three months ended April 30,
2020 to the three months ended April 30, 2021 was primarily due to the inclusion
of amortization related to identified intangible assets acquired through the
Luum Acquisition commencing March 8, 2021. The remainder of the increase was due
to the inclusion of amortization related to HSA portfolios acquired during the
fiscal year ended January 31, 2021.
Merger integration. The $8.8 million and $12.8 million in merger integration
expense for the three months ended April 30, 2021 and 2020, 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 the WageWorks
Acquisition. We expect integration expenses totaling approximately $100 million
in the aggregate to be incurred by the end of fiscal year 2022. As of April 30,
2021, we had incurred a total of approximately $87 million of non-recurring
merger integration costs related to the WageWorks Acquisition.
Interest expense
The $6.7 million and $12.3 million in interest expense for the three months
ended April 30, 2021 and 2020 consisted primarily of interest accrued under our
term loan facility and amortization of financing costs. We expect interest
expense to decrease as a result of the principal repayments under our term loan
facility and to fluctuate based on changes in prevailing interest rates.
Other expense, net
The $2.9 million increase in other expense, net, from $0.8 million during the
three months ended April 30, 2020 to $3.6 million during the three months ended
April 30, 2021 was due to a $5.8 million increase in acquisition costs,
partially offset by a $2.9 million increase in other income, net.
Income tax provision (benefit)
Income tax benefit for the three months ended April 30, 2021 was $3.5 million,
compared to income tax expense of $0.2 million for the three months ended
April 30, 2020. The $3.7 million decrease in the tax provision for the three
months ended April 30, 2021 compared to the three months ended April 30, 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
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contributions, and timing of card spend. Cost of revenue is seasonally impacted
as a significant number of new and existing Network 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 new Network
Partners and new accounts. These costs of services relate 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 described
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 of April 30, 2021 and January 31, 2021, cash and cash equivalents were $736.8
million and $328.8 million, respectively. Cash and cash equivalents as of
April 30, 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.
Capital resources
We have a "shelf" registration statement on Form S-3 on file with the SEC.
This 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 and capital
expenditures, 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.
Our credit agreement includes a five-year senior secured revolving credit
facility in an aggregate principal amount of up to $350.0 million, which may be
used for working capital and general corporate purposes, including the financing
of acquisitions and other investments. For a description of the terms of the
credit agreement, refer to Note 8-Indebtedness. We were in compliance with all
covenants under the credit agreement as of April 30, 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, with the remaining proceeds to be used for general
corporate purposes, which may include prepayments under our term loan facility
or potential acquisitions, including the acquisitions of Further and the Fifth
Third Bank HSA portfolio.
Capital expenditures for the three months ended April 30, 2021 and 2020 were
$18.0 million and $19.3 million, respectively. We expect to continue our current
level of increased capital expenditures for the remainder of the fiscal year
ending January 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.
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.
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The following table shows our cash flows from operating activities, investing
activities, and financing activities for the stated periods:
                                                                       Three months ended April 30,
(in thousands)                                                          2021                   2020
Net cash provided by operating activities                 $        30,918          $      15,026
Net cash used in investing activities                             (67,801)               (25,294)
Net cash provided by (used in) financing activities               444,853                (10,365)
Increase (decrease) in cash and cash equivalents                  407,970                (20,633)
Beginning cash and cash equivalents                               328,803                191,726
Ending cash and cash equivalents                          $       736,773

$ 171,093

Cash flows from operating activities. Net cash provided by operating activities
during the three months ended April 30, 2021 resulted from net loss of $2.6
million, plus depreciation and amortization expense of $31.8 million,
stock-based compensation expense of $12.8 million, and amortization of debt
issuance costs of $1.2 million, partially offset by other non-cash items and
working capital changes totaling $12.3 million.
Net cash provided by operating activities during the three months ended
April 30, 2020 resulted from net income of $1.8 million, plus depreciation and
amortization expense of $27.5 million, stock-based compensation expense of $7.4
million, amortization of debt issuance costs of $1.2 million, and other non-cash
items and working capital changes totaling $22.9 million.
Cash flows from investing activities. Cash used in investing activities for the
three months ended April 30, 2021 resulted from the Luum Acquisition for $49.5
million, net of cash acquired, $15.5 million in software and capitalized
software development, $2.5 million in purchases of property and equipment, and
$0.3 million in acquisitions of intangible member assets.
Net cash used in investing activities for the three months ended April 30, 2020
resulted from $11.8 million in software and capitalized software development,
$7.5 million in purchases of property and equipment, and $6.0 million in
acquisitions of intangible member assets.
Cash flows from financing activities. Net cash provided by financing activities
during the three months ended April 30, 2021 resulted from $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 $4.2 million. These items were partially
offset by $15.6 million of principal payments on our long-term debt and $0.4
million used in the settlement of Client-held funds obligation.
Net cash used in financing activities during the three months ended April 30,
2020 resulted from $7.8 million of principal payments on our long-term debt and
$3.8 million used in the settlement of client-held funds obligation, partially
offset by $1.2 million of proceeds associated with the exercise of stock
options.
Contractual obligations
See Note 6-Commitments and contingencies for information about our contractual
obligations.
Off-balance sheet arrangements
As of April 30, 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.
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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 ended January 31, 2021. There have been no
significant or material changes in our critical accounting policies during the
three months ended April 30, 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 ended January 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
three months ended April 30, 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 of April 30,
2021 were $736.8 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 of
April 30, 2021 was $74.5 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.
Interest rate risk
HSA Assets and Client-held funds. Our HSA Assets consist of custodial HSA funds
we hold in custody on behalf of our members. As of April 30, 2021, we had HSA
Assets of approximately $15.0 billion. As a non-bank custodian, we contract with
our Depository 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. The contract terms with our
Depository Partners typically range from three to five years and have either
fixed or variable interest rates. As our HSA Assets increase and existing
contracts with Depository Partners expire, we seek to enter into new contracts
with Depository Partners, the terms of which are impacted by the then-prevailing
interest rate environment. The diversification of deposits among Depository
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 our
Depository 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
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and government policies over which we have no control, such as the interest rate
cuts by the Federal Reserve associated with the ongoing COVID-19 pandemic.
Our Client-held funds are interest earning deposits from which we generate
custodial revenue. As of April 30, 2021, we had Client-held funds of
approximately $903.0 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 with Depository Partners. We deposit the
Client-held funds with our Depository 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 the U.S. and include deposits in a money market account that is unrestricted
as to withdrawal or use. As of April 30, 2021, we had unrestricted cash and cash
equivalents of $736.8 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.
Credit agreement. As of April 30, 2021, we had $987.5 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 1.86 percent at April 30,
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 at April 30, 2021 would result in
approximately $9.8 million of additional interest expense over the next 12
months.
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 of April 30, 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 the SEC's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures 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
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 of April 30,
2021, the Company's disclosure controls and procedures were not effective
because of the material weaknesses in internal control over financial reporting
at the Company's wholly owned subsidiary, WageWorks, described below.
Notwithstanding the ineffective disclosure controls and procedures as a result
of the identified material weaknesses in its WageWorks subsidiary, management
has concluded that the 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 in the United States of America.
In accordance with interpretive guidance issued by SEC 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 on March 8, 2021, management's
evaluation and conclusion as to the effectiveness of the Company's disclosure
controls and procedures as of April 30, 2021 excluded the portion of disclosure
controls and procedures that are subsumed by
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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 ended April 30, 2021.
Material Weaknesses in Internal Control over Financial Reporting
Management identified certain deficiencies in WageWorks' internal control over
financial reporting that aggregated to material weaknesses in the following
components of the Internal Control - Integrated Framework (2013) issued by the
Committee of Sponsoring Organizations of the Treadway Commission ("COSO
Framework"):
Risk Assessment - The WageWorks 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 - The WageWorks 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 - The WageWorks 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
The WageWorks 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 WageWorks subsidiary 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.
C. Information Technology General Controls
The WageWorks subsidiary 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. WageWorks' 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 of WageWorks'
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 of WageWorks on the
Company's internal control over financial reporting and continues to assess
changes driven by the integration of WageWorks 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 the WageWorks
subsidiary and the Company as a whole.


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In response to the COSO Framework component material weaknesses in the WageWorks
subsidiary's internal control over financial reporting, management has taken the
following actions:
•performed a 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 a third-party internal
controls advisor to assist with such efforts;
•developed and have begun to execute a plan to implement a periodic assessment
to monitor business changes impacting accounting processes and controls;
•incorporated certain WageWorks processes into the Company's existing
entity-level controls;
•established periodic reporting of the remediation plan progress to the Audit
and Risk Committee of the Company's board of directors; and
•developed and have begun to execute a plan to formalize documentation
underlying processes and controls to promote knowledge and information transfer
across functions and upon personnel changes.
In response to the material weakness "A. Accounting Close and Financial
Reporting," management has taken the following actions:
•incorporated certain WageWorks 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; and
•developed and have begun to execute a plan to assess 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.
In addition to the steps above, specifically to address material weaknesses "B"
and "C" above, the Company took the following measures:
•developed and have begun to execute a plan to consolidate service platforms
related to the contract-to-cash cycle which will reduce a significant number of
manual business process controls; and
•enhanced the design and have begun to monitor the operating effectiveness of
controls related to logical access and change management for relevant WageWorks
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 as 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 ended April 30, 2021 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
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