HealthEquity's (NASDAQ:HQY) Q4 2017 Earnings Conference Call March 21, 2017 5:00 PM ET
Richard Putnam - Investor Relations
Jon Kessler - President and Chief Executive Officer
Steve Neeleman - Vice Chairman and Founder
Darcy Mott - Executive Vice President and Chief Financial Officer
Peter Costa - Wells Fargo Securities
Stephanie Davis - JPMorgan
Mark Marcon - RW Baird
Sandy Draper - SunTrust
Randy Reece - Avondale Partners
Donald Hooker - KeyBanc
Steven Wardell - Chardan Capital Market
Good day ladies and gentlemen. Welcome to HealthEquity's Fourth Quarter of Fiscal 2017 Earnings Conference Call. Please note that this event is being recorded.
I would now like to turn the conference over to Richard Putnam, Investor Relations. Go ahead, Mr. Putnam.
Thank you, Andrew. Good afternoon and welcome to HealthEquity's fourth quarter earnings conference call. My name is Richard Putnam. I'm in charge of Investor Relations for HealthEquity. With me today, I have Jon Kessler, President and CEO; Dr. Steve Neeleman, Vice Chairman and Founder of the company; and Darcy Mott, our Executive Vice President and Chief Financial Officer participating with us on the call today.
Before I turn the call over to Jon, I would like to remind you of a couple of things. First, a copy of today's earnings release and the accompanying financial information can be accessed on our Investor Relations website, ir.healthequity.com. Second, a reminder to those joining us on the call today that today's discussion will likely include forward-looking statements, including predictions, expectations, estimates and other information that might be considered forward-looking. Throughout today's discussion, we will present some important factors relating to our business, which could affect those forward-looking statements. These forward-looking statements are subject to risk and uncertainties that may cause our actual results to differ materially from statements made here today.
As a result, we caution you against placing undue reliance on these forward-looking statements. We encourage you to review the discussion of these factors and other risks that may affect our future results or market price of our stock that are detailed in our annual report on Form 10-K filed with the SEC on March 31, 2016, along with any subsequent periodic or current reports, including this year's fiscal 2017 10-K that we expect to file within the next couple of weeks. We are not obligating ourselves to revise or update these forward-looking statements in light of new information or future events.
With all that out of the way, I will turn the call over to Jon Kessler.
Thanks, Richard and it's been a long and eventful winter our here. And I'm pleased to welcome everyone. Thankfully you could be here on this first day of spring. It certainly feels spring like out here in Utah. I have a few remarks about our fourth quarter and full year operating results and then we will turn the call over to Steve, to talk about sales results and Darcy, to discuss financial results and guidance before we open the phone lines for questions.
HealthEquity finished fiscal 2017, the same way we started the year, outpacing the market in growing HSAs and custodial assets, which resulted in substantial growth of both our top and bottom line. Since our IPO, we're tried to establish a cadence reporting each quarter on our growth in four key metrics of our business, which are revenue, adjusted EBITDA, HSA membership and custodial assets. Because this is immediately after the end of the fiscal year, we reported on growth in custodial assets and HSAs for the fiscal year 2017 about a month ago. We reported 28% growth in HSAs and 37% growth in custodial assets.
We're reporting today that this resulted in revenue growth of 41% year-over-year in fiscal 2017 to $178.4 million. And that revenue growth along with scaling in our business in turn resulted in adjusted EBITDA margin expansion. Adjusted EBITDA grew 55% year-over-year in fiscal 2017 to $62.8 million and adjusted EBITDA margin in fiscal 2017 was 35%, compared to 32% in fiscal 2016. So the top line continued to show significant growth on a much larger base and profitability continues to outpace revenue growth as we continue to gain market share as measured by HSAs and custodial assets. I'm truly, truly grateful for the talented purple team that continues to perform, building the base of a strong profitable business for the long term.
Let me put our fiscal 2017 operating results in a bit of a longer term context. At the time of our IPO, we presented an annual revenue growth target of 25% to 35% and an annual adjusted EBITDA growth target of 35% to 45% over our first several years as a public company. With our third fiscal year of reporting now completed, I'm pleased to say that HealthEquity has more than delivered on its commitments. Revenue on a year-over-year basis grew 42% in fiscal '15, 44% in fiscal '16 and now 41% in fiscal '17. Adjusted EBITDA, also on a year-over-year basis grew 60%, 61% and 55% in fiscal '15, '16 and '17 respectively. This resulted in three year revenue CAGR of 42% and a three year adjusted EBITDA CAGR of 59%.
From FY '15 through FY '17, HealthEquity added 650 basis points to adjusted EBITDA margins. Note also, that the above results were achieved while growing the company's cash and equivalent from 108 million in the reported quarter after the IPO to 180 million at January 31, 2017. The message that you should take from this as our shareholders' is that everyone in HealthEquity takes the commitments that we make to you as well as to our members and partners very, very seriously, that's two verys'. We get asked frequently about updating our revenue and adjusted EBITDA growth targets, now thinking about the next intermediate term.
As all of you know, there is a lot of optimism and its justified in our view about the growth of HSAs. A report issued just this week by Marsh & McLennan and widely distributed on Capitol Hill puts it pretty blindly, bluntly one might say. Health Savings Accounts, promote responsible use of healthcare resources. With proper policy and regulatory support the HSA could be a key vehicle for improving cost across Medicaid, Medicare, the individual market and employer population, in other words, every segment of American healthcare. Of course, nobody can be sure what will come out of Washington, when or the impact quantitatively on the growth trajectory of our market.
However, we at HealthEquity can make to you two commitments today. First, HealthEquity fully expects that we will outpace the HSA market growth resulting in continued market share gains on a year-over-year basis. Second, we will continue to scale and as such expect to have the opportunity to expand EBITDA margins over that same period. I say opportunity because of course as we've said before, if we identify investments with strong returns to you our shareholders, we will not hesitate to make them and we will wherever possible tell you about them in advance.
Now, I'd like to turn the call over to Steve to report on sales performance and looking forward, as well as on changes in our sales and marketing leadership. Steve?
Thanks, Jon. In February we reported that HealthEquity had opened approximately 668,000 new HSAs and added nearly $1.4 billion in custodial assets in fiscal year 2017. At that time we did not have any industry data to provide context. Now, we do and the data demonstrates that HealthEquity along with our growing network of employer and healthcare partners [ph] strengthen this position as the industry's organic growth leader in the sales cycle just completed.
According to Devenir's year-end market survey, which was published shortly after we announced our sales results, excluding competitive acquisitions, HealthEquity added more HSAs in calendar year 2016 than any other HSA custodian. In fact, through organic growth HealthEquity added more HSAs than the number two and number three competitors combined.
Second, the $1.3 billion of organic custodial asset gain we announced in February that excludes assets from the acquired M&T Bank portfolio is likewise larger than the organic asset growth of any other HSA custodian reported by Devenir. And last, overall Devenir reported market growth of 20% in HSAs and 22% in custodial assets, compared to HealthEquity's reported growth of 28% and 37% in HSAs and custodial assets respectively. Devenir estimates that HealthEquity's market share at 13% expressed in HSAs and 12% expressed custodial assets, is built up approximately 2% over last year's Devenir estimates.
Finally, it is clear HealthEquity start growth in invested custodial assets well above the market. In February, we announced that custodial assets and investments had grown 62% year-over-year for book. According to Devenir, the industry-wide investing grew 29%, less than half the rate of HealthEquity's growth. These market beating results are driven mostly on part to the efforts of HealthEquity advisors, our first of its kind regulated investment advisor delivering ultra low cost investing and personalized investment advice to HealthEquity members.
What I draw from our own experience and from research such as Devenir's, is that politics aside, HSAs are rapidly becoming the new normal as consumers work to control healthcare cost. While HSA plans to have significant deductable's and there is much work to be done to help consumers make smart healthcare spending and saving decisions, we always maintained that HSAs are actually are the anti-dote for rising healthcare cost. The data continues to bear this out, for this reason we remain committed to our mission to build health savings for all Americans.
The new sales year is already well underway. I spent a better part of last week with our sales and marketing teams at our annual planning meetings. These hardworking and dedicated groups of HSA experts are in full swing developing relationships, building their sales pipelines and already enrolling business for our new fiscal year. One of the benefits of our b-2-b-2-c strategy to partner with quality health plan and large employer network partners is that we truly do not have the cyclical downtime as some sales teams experience.
We have the benefit of promoting the adoption of HealthEquity HSAs and growing account balances year around. Our market facing teams continue to add top talents and to evolve our solution, so that we can be prepared to capture an outsize share of the market. I'm always inspired by the commitment of HealthEquity team members and for the time you're going to spend away from your families to grow our business and thereby help millions of Americans.
As you know, we are in the process of recruiting new sales and marketing leadership for this team. As we've said in previous calls, the tenure and experience of our sales team is on rival. In fact sales team members have the longest average tenure at HealthEquity, compared to any other part of our organization. This stability has given us the luxury to conduct thorough national search for our sales leadership and we expect to announce the results to you very and another very shortly.
I will now turn the time over to Darcy to review our financial numbers for the fourth quarter and year end and to offer guidance for the year ahead.
Thanks, Steve. I will discuss our results on both a GAAP and a non-GAAP basis. A reconciliation of non-GAAP results that we discuss here to their nearest GAAP measurement is provided in the press release that was published earlier today. I will first review our fourth quarter and year-end financial results of fiscal 2017 and then I will update our guidance for the fiscal 2018.
Revenue for the fourth quarter grew 30% year-over-year to $46.8 million. Breaking down the revenue into our three components, we continue to see growth in each of service, custodial and the interchange revenue during the quarter and the full year. Service revenue grew 21% year-over-year to $20.6 million in the fourth quarter.
Service revenue as a percentage of total revenue declined to 44% in the quarter, down from 48% of total revenue that it represented in the fourth quarter of last year. As custodial and interchange revenue streams became more predominant. Service revenue growth was attributable to a 36% year-over-year increase in average HSAs during the quarter partially offset by 11% decrease in service revenue per average HSA.
As we indicated last quarter, we expect service revenue per HAS declines to moderate back to the 5% to 10% range going forward. As discussed on our last several earnings calls, the moderate expected declines of service revenue per account will also lately be offset by growth in custodial and interchange revenue per account as our average custodial asset balances increase.
Custodial revenue was $16 million in the fourth quarter, representing an increase of 44% year-over-year. The driving factor for this growth was a 37% growth in ending total custodial assets in the higher annualized interest rate yield on custodial cash assets of 1.59% during the quarter.
Interchange revenue grew 33% in the fourth quarter was $10.1million, compared to $7.6 million in the fourth quarter of last year. Interchange revenue benefited from the 36% year-over-year increase in average HSAs in the quarter compared to the fourth quarter last year.
Gross profit for the fourth quarter was $24.2 million, compared to $18.4 million in the prior year, for a gross margin level of 52% in the quarter versus 51% in the prior year. Rising gross margins are the result of increasing mix from custodial and interchange revenue. The mix shift will continue to drive gross margin expansion as accounts mature and their balances grow.
Operating expenses were $18 million or 39% of revenue compared to $14.1 million or 39% of revenue in the fourth quarter last year. Income from operations was $6.2 million in the fourth quarter, an increase of 42% year-over-year and generated an operating margin of 13% during the quarter. We generated net income of $4.1 million for the fourth quarter of fiscal 2017, compared to $3.1 million in the prior year.
Our GAAP diluted EPS for the fourth quarter of fiscal 2017 was $0.07 per share, compared to $0.05 per share for the prior year. Our non-GAAP adjusted EBITDA for the quarter increased 33% to $11.8 million, compared to $8.9 million in the prior year. Adjusted EBITDA margin in the quarter was 25%.
Full year results for fiscal 2017 included; revenue growth of 41% compared to last year, increasing to $178.4 million. Gross profit was up 46%, as the revenue mix continues to increase in favor of custodial and interchange revenue streams, driving our gross margin for the year to 60%. Income from operations grew by 58% as we continue to scale our business model, operating margins were 23%, compared to 21% last year. Adjusted EBITDA grew 55% year-over-year to $62.8 million.
Turning to the balance sheet, as of January 31, 2017, we had $180 million of cash, cash equivalents and marketable securities with no outstanding debt. We generated $46 million of cash flow from operations during fiscal 2017, compared to $27 million during fiscal 2016, a 72% year-over-year increase.
Before I turn to guidance, I want to make you aware of one correction to the metrics that we published last month. Our average daily custodial cash balances year-to-date and quarter-to-date were revised slightly upward as we completed our final close in reconciliation. The revised amounts are included in the earnings release that we published earlier today.
Turning to guidance for fiscal 2018, based on where we ended the year, we expect revenue for fiscal 2018 to be between $220 million and $225 million; net income between $30 million and $34 million; GAAP diluted EPS between $0.50 and $0.55 per share, resulting in adjusted EBITDA between $77 million and $82 million. Our GAAP diluted EPS estimate is based on an estimated diluted weighted average shares outstanding of approximately 61.5 million shares for the year. The outlook for fiscal 2018 assumes a projected effective income tax rate of approximately 37%.
Before I turn the call back to Jon, I would like to highlight two items reflected in our guidance. First, our guidance reflects an incremental $1.5 million of service delivery expense in each of the first and second quarters of FY '18 related to fraud prevention. With their growing popularity as a tax advantage savings vehicle, drawing balances and somewhat less frequent monitoring than bank accounts, HSAs are increasingly being targeted by fraudsters, trying creative means to gain access to these accounts. HealthEquity takes this threat to our members' health savings and personal information seriously.
We have to date successfully mitigated fraudsters without a non-visible impact to our margins. To further protect HealthEquity members, we are implementing a variety of additional safeguards and controls. The incremental expense reflects the cost of testing, training, partner and member communication and other costs of rolling additional fraud protections out through the service delivery organization. We think you will agree that this is money well spend and we want to do it in a way that maintains the purple service for which HealthEquity is known.
Second, as we've done in recent reporting periods, our full year guidance includes a detailed reconciliation of GAAP and non-GAAP metrics. This includes management's estimates of depreciation and amortization of prior capital expenditures and anticipated stock compensation expenses.
With that, I will turn the call back over to Jon for some closing remarks.
Thanks, Darcy. With the year-end a little bit of time elapses between the close of the year and when we report these numbers and so it is easy for us to be brassy about the results. But I have to tell you that I'm really, really pleased about what the team delivered in terms of Darcy's reporting of the financial results and Steve's reporting of the sales results, which kind of the way he put it sounded like a little bit of a butt kicking and that's kind of good. But I'm even more excited that the ubiquitous vision that we have discussed many times is closer today than it ever has been. We truly believe that every American family should and ultimately will have HSA alongside of truly affordable health coverage. And that like 401 (NYSE:K)'s and IRIS and other retirement plans, HSAs will become a staple of overall investing in retirement planning.
There's a lot of discussion right now in Washington about HSAs and that of course increases our optimism. But as Steve noted, the trends we're describing and the vision that we've laid out is truly driven by what is working and the politics is just kind of adapting to that. The overall vision of where we believe this industry will go is likely to remain intact whatever the results in Washington may be. So it's pretty exciting times and we're particularly thankful for the dedication of the now more than 800 HealthEquity team members as well as the hardworking professionals from our clients, our network and ecosystem partners and support providers across the country that are helping us drive this vision to reality.
With that, operator, let's take some questions.
Ladies and gentlemen, the question-and-answer queue is now open [Operator Instructions]. We'll be taking our first question from the line of Peter Costa from Wells Fargo Securities. Your line is open.
Good afternoon everyone and thanks and good quarter. Can you tell me if your decision not to give or continue the revenue and EBITDA growth guidance goal - the long-term guidance goal numbers. Is that because of your concern that it's just too hard to forecast at this point because of all of the different things going on in Washington, most of which are positive or is that because your concern is that it's harder to get to the numbers that you had in the past?
No, we really aren't making any commentary on it one way or the other. We just wanted to recognize that what is - if once the intermediate term is now has happened and so we kind of wanted to comment on where we've been and we may ultimately provide incremental quantitative guidance, but for the moment again with all the stuff going on in Washington, I think what we wanted to be able to say to you here is, we're going to continue is the commitment we've made internally and as I said, we take these pretty seriously is we're going to continue to outpace the market and we're going to continue to have the opportunity to grow profitability. And as things settle down a little bit and we feel like we can expand on that we will, but our point wasn't to sort of cut it off, but rather - we do get asked about this a lot and we never want to give statements we shouldn't be offering and so we're sort of saying, the intermediate theory is sure enough, the promises we made, we more than delivered on it.
Yeah, and I would just add to that though, I mean if you calculate from the guidance we gave you, to the midpoint of revenue and EBITDA, those numbers are both like in the 25% to 26% range. So it's on the low end of the revenue and it's down below what that IPO guidance range was and so that's from organic business that we have. And as we've said before, if we're able to acquire some portfolios that would that EBITDA growth we expect, but - and the reality is that as we've grown, we are more constrained by the actual market growth than maybe what we were in some of those earlier days.
To that point just a follow-up, as your closest competitors get closer and closer to you in terms of the portals that they're offering to their customers and as sort of the smaller players get out of the market and continue to be worse than less important in the overall market growth. Your growth should naturally sort of approach the market growth, do you see your ability to stay ahead of the market growth as being something that you can maintain for a long time at this point? Do you see some things that are incremental that you have coming out in terms of your portal and what you're offering? Looks like that you think will make that differential that much better or is there anything in your mind that's going to ultimately not allow not allow you to maintain that here in the near term.
Yeah, this is Jon. I'll comment on that Pete and then ask Steve to give a comment on - in terms of the sort of the market texture. I think we're guiding transaction of what the market was able to do this year, in the year just closed, either it's the case that we're offering a hell of a product, our team is doing a hell of a job or both because - I think it's fair to say that our competitors, our nearest competitors have brand and other resources that would be the envy of anyone and yet this will company out new jobs, double them up in terms of market growth on the organic side and that led something is clearly a little bit of why we saw some of M&A activity perhaps and what not. So I guess the premise that I would start with is the clearly held equity - whether you think about from a functionality or broadly value proposition perspective, years to day has in the recent past and will continue to deliver values in excess of its competitors.
The second kind of part of your question is, how you keep that going and the answer to that is, you listen really closely to your customer, you leverage the fact that you have your ear to ground more so than anyone else both in selling and with your existing partners and figure out what customers need and you do flipper it to them. And so a great example of that in my mind again and I look at this relative to our nearest competitors is what we have done over the last few months even recently but just going back little further with regard to our investors. Congress is now debating a doubling of the amount of money you can contribute to HSA, which sort of puts an explanation point on the fact that this ultimately is a vehicle that is really powerful for long term failure and yet when we look at what we are doing and so our response to that has been to deliver investment advice, to deliver low cost funds and even on very low balance account to deliver highly cost effective to continue to do those things and to comply the fiduciary role whether ultimately implemented or not, that is our response.
How others have responded - I mean you can look at it and you know as well as we do. So there will be more of that, so that's one area certainly where we intended to stay ahead and beyond that and see if we can comment on this, we are look at ways to more and more with regard to helping people with the spending of the equation, that is to stay making all those fools that they are employers and help clients are paying for, we will be available to them and really useful and meet them where they are. So I feel pretty good about this and certainly feel like we are maintaining that edge, of course people are doing the stuff we were doing three four years ago, God Bless America. But if we are three four years ahead that is pretty good. Steve anything to add to that?
Peter, your question reminds me a little bit when one of our first health plan partners I was sitting with them, this was about eight years ago and they said you are telling me, you are going to build your business and all you are going to focus on the self-accounts, you are competing against bunch of banks, they are going to do all the other stuff. And I said yeah, and if you can survive and thrive you will probably be the best in the world because that's all you do, that's your single focus, whereas your competitors who probably not be as good as you and it has taken a tremendous amount of work, I can tell you though, Jon mentioned we are over 800 team members here, everyone here is committed to the mission and that's to build out savings, save healthcare, help people save long term retirement and I think we are mission driven organization and I think at the end of the day, people can copy us, they will of course, we actually think that it in some respect the right thing. Because for a long time our competitors were actually I think turning off the market little bit because they weren't doing a good job. But now, people are copying this and we are going to keep innovating and I mean the market because this is how we will survive by being think best and achieve our mission.
That's really helpful. Thank you. Just one final - couple of record keeping things what is the yield on average cash AUM and what interest rate are you forecasting going forward for your guidance?
For the fourth quarter it is 1.59%, is that what you ask for or what was reported?
So, you have seen a little bit of uptick in range, we have said that as rate increase that we would get the benefit from that on that portion of the portfolio which we placed a new deposit. We intentionally did not give any guidance into our number, we gave a fairly broad revenue number that, we will give a lot more of that in our first quarter earnings call, when we have reflected the AUM that comes in the first quarter and we work through some of these depository agreements that is already put in place and that we are putting in places as we place those funds in all agreement and so rate increases are helpful to us as you know and we will report with more detailed when we report our first quarter.
Great thank you very much.
Thank you, our next question comes from the line of Stephanie Davis from JPMorgan. Your line is open.
Hey guys. Thanks for taking my question.
Could you comment on any changes that you have seen in the competitive landscape just given the increasing focus on HSAs that we are seeing in Washington, has there been any buzz or new entrants there, anyone kind of get part of the HSA pie?
Well, I think there is a lot of discussion of it, probably the biggest thing that we have seen is folks who kind of missed out on rev 1 and rev 2, wondering why they did. So we see that when we talk about just if you are interested in the M&A environment where you have sellers thinking maybe I should try and stick this out. I think for the most part though what is interesting step is the players who are in this market, if you look at, let's say players one from ten as reported by Devenir's then I want this one - of these are all companies including that we are in this market, 12 or 13 or 14 years ago and I maybe missing one but you get the point. And so to some extend to accept that some lee rule here, wow, now they are really going to focus, I heard that five years ago, that I heard that nine years ago when I took this job and I hope they do because as Steve said that gets us closer to our mission.
But I don't really see - think as people look at this one of the things about being a little bit of as you commented before is what we do is difficult if this not fit in a box naturally, the stuff is easy to do, the debits and credits, everyone will do, everyone was doing this ten years ago and they are doing them today, that will get you something but it will not get you - it wasn't up into it, it will get you a very thin slice of the pie, we will get you a bigger slice of the pie and using the bigger Steve mentioned earlier, we took more than 20% of the new account growth this year using Devenir's data is really look at there is being differentiated, it is reset and for us that's is how really focusing on what HSA is about, which is helping people spend wisely and save well and so that's kind of where it is right now.
And as a follow up to that when you think about the M&A pipeline should we then assume that on hold for the interim or are you still seeing some activity?
Yeah, we were thinking of figuring someone would ask, we were thinking about this before the call and how to address it, I think what has happened very candidly is that some of the sellers that were sellers have I think - we think have gotten little lower this year. That is to say that, you have people who maybe at an executive level, in some of these rooms have never paid attention to this market and our sort of making the same, coming to the same conclusions the predecessors did a decade ago, how hard it could be? Well it turns out, it is pretty hard and if it was, it wouldn't require kind of focus that we put to it or either that, we are really lucky - I don't know maybe both.
And so I think but given that sort of the way we hear people talking, we are not going to do anything that really doesn't make sense from a return on investment capital perspective for you our shareholders and so if that mean, not doing all them - we are not going to deal and in addition if that means looking the flipside of that I suppose is because it is clear that there is going to be sustained growth, there is something we can look at that might be slight variants on direct portfolio acquisition that might make a ton of sense in this environment, other ways to stem the cash as it where and I'm not trying to say that but I just did, so I can't take it back but strike that from the record but in any event that kind of what we are thinking about, so I think it is fair to say that we do have some concern about sellers being out over their sleeves and the way we address that other than try to be realistic about it is that stick to our discipline and recognize that underneath is an opportunity to look at some of the different ways that you can grow beyond the organic stuff that we do every day and really explore those. That's what we are doing.
Alright, thank you again for taking my questions.
Our next question comes from the line of Mark Marcon from Baird. Your line is open.
Good afternoon. Congratulations on a great year and thanks for taking my question. Wondering can you just give us a little more detail with regards to the incremental service costs that are coming in for the next two quarters like specifically where it lays out and how to think about it beyond on the next two quarters?
Sure. So, as we discussed, efforts that we are trying to do help not only prevent but to help our members protect their assets and then we're providing the best tools available. So, that includes a lot of different things, Mark. It includes even having more people on the phones to take a little bit more time with members in helping them navigate through some of these areas, providing some tools that we can use and our service stations can use to help protect against identity theft et cetera et cetera. And so, there is a variety of - it will all come into that service cost line in our P&L, but it's made up of both people and technology and those types of things.
Go ahead, Mark, sorry.
I am sorry. In terms of the service cost, is that just on the service fee line item, so specifically...
On the service cost line item.
Okay. Great. And then just to be clear, it was $1.5 million of an increase sequentially for each of the next two quarters.
No, it was $1.5 million above for our historical yield, our margins would be in that first and second quarters.
Okay. Just for those two. Great.
What we are - Mark, what we are trying to do here is just to get a feel for it, what - the legal authorities have told us and there has been some public reporting on this is really about an increase in people who are trying to find ways into some of the systems that some of these HSA provides to some of the smaller that maybe haven't made the kind of investments that we made one ever wants to be too competent.
What this is all about, though, and this is the reason it ends up being part of service cost is really about the ways in which fraudsters can unfortunately try and trick individual consumers or employers or whatnot into either giving up or somehow compromising their credentials or identity and what have you and we found over the course of the last few quarters that the best things we can do to protect people are really about how they are educated about modest protections that we've installed within our systems that hopefully don't inconvenience consumers but really protect them, make sure they know when things are happening.
And those are changes we want to - as we broke them up, we want to do them right. We want to make sure we provided the right resources within day-to-day service delivery and so we plan for kind of a little bit of incremental bump for a relatively short period of time as we roll those out and again it's kind of in the vein of when we do something that's a little different, we want to tell you before we do it, so that you don't think we are making excuses afterwards.
Much appreciated. Can I just squeeze in two conceptual questions and one numbers question? In terms of the numbers question, just what CapEx is going to be for the year and in terms of the conceptual question, are you seeing any changes in terms of the dynamics with regards to the new HSAs that are coming in, in other words, are they aging in the same manner where you're typically seeing the cash AUM or account increase at the same level as it has historically as it ages? And then lastly, just given all the political discussion that's out there, do you think that buyers are freezing up for just a little bit or it just doesn't matter because it's not really until the fall that they will be making decisions anyways?
So, on the CapEx question, as a percentage of revenue, our CapEx has been in the 7% to 8% range for the last little while and we would expect that that would continue as a percentage of revenue going forward. Because I was looking at that, I missed your second question.
I can take that. That was more for us. Darcy is clicking in real time. But with regard to your second question - it was sort of a two-part. Part A was about whether we saw some differences in the character of more recent HSAs versus older ones. And part B was about buyer behavior and relatable to Washington discussion. How about I'll take part A and Steve Neeleman will take part B.
On part A, well, they are not old yet. So, we don't really know. But, sorry, that's just me being smart. But nonetheless we did report an increase in our average balance on a year-over-year basis that was pretty substantial compared to the industry numbers that Devenir did are showed and I think what that really reflects is the fact that maturation of the accounts is continuing.
And, of course, from an expenditure perspective, as we talked about this last quarters, it's something we are really just at the beginnings of, but using the data that we have in the various ways, we have to engage our members and the ways they want to be engaged to try and move that curve to sweeten that curve to get people into the mode of saving even quicker. In whole, one of the advantages that we bring and we don't talk about this so much in these kind of settings but we talk about it a lot in sales settings is there are a lot of spenders out there.
There are some savers out there. There are some super savers out there. There are people in between and one of the things you get with our if you get real resources for everyone anywhere on that continuum and from the person who is trying to figure out at 3 A.M. how to - they're worried about a new expense that's shown up to the person doing their annual allocations between their various retirement accounts and trying to maximize every tax dollar.
Every one of those people has resources at health equity that they don't have anywhere else and so we are happy to meet anyone where they are on the continuum. But as you say, ultimately one of our real opportunities as a business is to move people along that continuum to become better savers and spenders of your dollars. So, Steve, second part was more about market reaction.
Yeah, so this is - look, I think there has been a decided tone difference, Mark, over the last several years and I think it's gotten a little bit better even in the last six months. We spent a lot of January, February, March, April at these conferences where you are meeting with employers and health plans and the like and years ago people used to equate HSAs with high deductible plans.
And as I said in my prepared remarks, I think the tone changes. People are now saying, look, whether it's because of ObamaCare, which almost validated high deductibles, right, I mean, We've lost all of our cheers a few years ago and President Obama said, hey, 3,000 high deductibles is not that high anymore, right.
So, now, HSAs have become the anecdote. And so I was with one of these conferences a couple of weeks ago and there was a left cost gentlemen that helped out the Obama administration when we were implementing ObamaCare and he said something that was very interesting and almost flurry estimates you said. I think HSA is part of a solution, acknowledge that people of lower income brackets maybe don't have enough money to fund the HSAs as they should be.
He said I even think government should take a role in helping people fund their HSAs. But this would never come out as someone's mouth four years ago, especially someone that was out involved with kind of [indiscernible]. And so, this is what I think. I think that there is a decided tone difference. I think employers are getting the message. They are kind of headed towards higher deductibles anyway, why not make some tweaks in their plans, so that they can now have money to fund the HSAs.
And it's really I think a lot better. And so what that could mean in the near-term we're always trying to be very thoughtful. We don't think there is going to be this like bumper crop over the top of it, but we don't know it could be, but we think it's more of just more and more employers not only saying this is something we want to do and we want to do with quality. We want to the best in class to do it for us and with us and then we are going to also make sure we fund these accounts in a way that can make this an easy choice for their employees to make. And, look, and whether that's happening with us or our competitors, I think it truly is a rising tide is always off shores.
Great to hear, thank you.
Our next question comes from the line of Sandy Draper from SunTrust. Your line is open.
Thanks so much, a couple of questions. One, Darcy, could you just remind us when you look at the return you get on the cash for the custodial spread versus the investment amount? What's come out of Washington? It looks like there may be more of an opportunity to save. And overtime we could see more investment balances and just trying to recall how that dynamic impacts, one, total revenue opportunity but also the margin. That would be the first question.
Yeah. So, Sandy, we look at both being important. We think that most people and we've looked at this data over and over again both for savers and spenders. Savers typically have actually more cash in their HSAs before they start investing. They usually keep something just for emergencies. As they are prudent, they may keep their deductible, they may keep their out-of-pocket max. But they generally have a little bit higher average cash balances.
And so, what we are trying to do is move people from spenders up to savers and from savers to investors and we are absolutely fine in the realm of, yes, we get a yield on the cash portion of the dynamic, but the investment portion is just additive to that and we target that we are going to get about 35 to 40 bps on the invested portion. But if we got to a world where people actually had $5000 of cash and $15,000 or $25,000 in investments, we would love that world. It would be very profitable for us.
Okay. Great. That's really helpful. And then circling back to the call back on the - when you announced the member numbers, there is some little bit of consternation about - it seemed like slightly higher churn. Just wanted to see if you could sort of give any more commentary about anyone without naming - what drove the increase churn and as you guys focus, are there ever times where you've got a legacy client that maybe isn't saving a whole lot or the base isn't saving a whole lot that you are less focused on retaining or basically do you view it as every year we can try to educate and we are not going to give up on that client.
A - Jon Kessler
It's a great question, Sandy. I would say this what we do and I'll thank our partner relationship management team and account executives for this work. The way we approach this is for every one of our partners, again now approaching a thousand of them, we do a monthly partner health report.
And as you suggest, some of the variables that go into that report are sort of externally facing driven ones, what kind of customer loyalty are we seeing from the members of that partner, from the partner itself, but as you suggest, one of the important things is, is that partner or its accounts as a whole progressing along that line of account maturity and you are absolutely right. It's important that we deliver on that promise of helping people become better savers and spenders.
There are factors that are beyond our control. A big one, a huge one is the plan design, the decisions that that employer or whatnot is making. And those sort of go into our thinking about each partner and then, of course, in addition to that, there is a little bit about the level of trust for a lack of a better term between the employer itself and the team members of that employer that how receptive people are to the message. But I think the essence of your question is correct that is to say that one of the things we can do to drive retention is the same thing we would be doing to drive value and that is help the member succeed. So, that's what we are trying to do.
Great, thanks so much.
Thank you. Our next question comes from the line of Randy Reece from Avondale Partners. Your line is open.
Good afternoon. My first question was I was wondering what you would assume for stock comp expense in your fiscal '18 guidance?
If you go to the release, Randy, and the back portion of it, there is a reconciliation between -
Ah, there we go.
Net income and there is a stock-based approximately $12 million.
That's helpful. Beyond that, just looking at your guidance excluding the step-up that you are taking for cyber security related expense and related account servicing, I was wondering where you are going to get operating leverage this year, because it looks like you have some considerable operating leverage if you exclude that $3 million step-up in expense?
Well, I think that we've always strived to gain leverage within our operating model. The challenges that we've had in the past like you know is account fees per account have come down, then getting some of that leverage to play itself out has been a great effort by the team. So, one thing we think is that as we've said the decrease that we saw overall in that line item will go down more into that 5% to 10% decrease on a unit basis.
So, that's a little bit better leverage than we had this last year. The other leverage point really on the revenue side comes as we just roll balances both cash balances and investment balances and we make a conservative effort to help people understand that they should be savers and help focus them on that.
On the cost side, notwithstanding what we said, we are going to spend. We are continually always looking for ways to provide service delivery on a more cost-effective basis and so we've seen improvements in that and our gross profit margins every year for the past several years and we will continue to play that as much as we can notwithstanding these additional expenses that we are talking about.
On the operating expense side, as we grow, when we went public, the G&A expenses started popping up at a higher level as a percentage of total revenue just from basically a public company cost. We hope that we can get some leverage out of that going forward if we can maintain as a percentage of revenue, great, if we can actually tweak that down a little bit as we continue to expand the revenue that would be helpful.
We've had leverage on the sales and marketing line. However, with the opportunities that lie before us, we are not afraid to go and spend a little bit more on the sales and marketing line if we can take advantage of opportunities that are forthcoming, because of either change in law or change in opportunities.
On the technology and development, we haven't thrived to leverage that to squeeze every last dollar out of that, because we believe in continuing to invest in our platform and we capitalized a lot of that software development cost and then that comes back in as future amortization in the technology and development line. So, I would say on the OpEx line, maybe a little bit in G&A that we can hopefully get over the next couple of years, but primarily up at the margin line and in the revenue line frankly.
Alright, very good. Thank you.
Thank you. Our next question comes from the line of Donald Hooker from KeyBanc. Your line is open.
Good afternoon. How many HSA members are currently contributing in your base? How many HSA members are currently contributing the maximum amount to their HSA?
It's a very small number. This is what I can say, Jon?
Yeah, fewer than 5% and it's a great question, Don, because just to kind of think about this discussion about rise in contribution limits, let's just say that, let's just take our existing membership without any growth and so forth, roughly two and three quarter million accounts. And let's just say that 10% of that group maxed out, which would be less than max-out in their 401(k) today, which is reasonable considering the sort of tax power of the HSA and applying reasonable percentages in terms of the number that are single and so forth.
That alone, doubled the current contribution limits would be over $3 billion of AUM and contributed in. And obviously that would affect our margins revenue and so forth significantly. So, well, we are not kidding ourselves. It's - 50% of people don't max out their 401(k) and 50% of people are not going to be maxing out their HSA that we are going to do everything to help them do so. But we do see continuing to move people along that continuum as a real opportunity. But as you say, today the number is still very, very small, well under 5% and again I think that reflects the fact that there is a long way to go in terms of educating people about what an HSA is for and how to use it to your maximum advantage.
By the way, Don, welcome to the group and welcome to the family. Thank you for the time you've given to us in the last few months.
Sure. And the other question you commented around helping consumers make their decision, I know this is a while back that you had a partnership with [indiscernible] and Change Healthcare and I think there may have been a couple other interesting technology partnerships and I was curious to what extent those relationships have grown or not grown?
Yeah, Steve, do you want to comment on this?
Sure. So, we - in addition to the ones you talked about, there is several telemedicine providers. You mentioned the ones that are what we would refer to as transparency providers looking for lower cost alternatives that we think the ecosystem continues to expand. I you want our list we have that group you mentioned transparency, we have telemedicine providers that - typically what the approach we take, Don, is that we wait until in partnership with one of our network partners, we identify one of these ecosystem partners that are performing well and maybe we are under contract with the network partner and then we link it up, we integrate and then we start to promote.
We have different ways. We promote through different mediums including the fact that as we mentioned before, we said a lot of people that come to our website every month and a lot of people that we chat with in different means and so we start to promote them and then there is a few that because we only have so much bandwidth to promote things that we have entered into some revenue share agreements and things like that and then we also have some - I would say like wellness providers and then just even like some second opinion providers that do the calc.
So, I can tell you that the ecosystem continues to grow. We are doing in a soft manner because we don't want to just throw a bunch of stuff out there that isn't going to be used and now we are starting to work on different ways to segment population to be able to provide the right message at the right time for the right person because somebody, let's say, there is somebody that clearly isn't using our HSA to pay claims, right.
They are using it as a long-term saving device. Our message to them is going to be, hey, keep doing it, invest, how can we help kind of that side of the house, whereas somebody that's clearly using this more spending account, we are going to be sending different messages them and part of maybe just more cost alternatives. And I think our partners appreciate this. What we love about this ecosystem approach is that this is where if you think about it, we are actually by doing this, really helping out some very key positions to health equity.
We are helping out our partners through often times made a bet on some of these ecosystem partners [indiscernible]. We are helping out our members because our members believe additional help and then kind of neat way if someone spends less, that means we get to manage more money, so we help out certainly our team and our shareholders and so we think it is still quarter omission, we realize this is going to take long term to shake out but because of our unvaried solution that we are the first company in the country to really roll out and our ongoing efforts are and I think we are still well ahead of our peers on the efforts.
Okay thank you.
Thank you, our next question comes from the line of Steven Wardell from Chardan Capital Market. Your line is open.
Hey guys congrats on the good quarter.
Can you - so you sided that service revenue - pricing in service revenue is down something like 11% why was it down by 11% in the past quarter and you said it might return 5% to 10% decline in future. Why do you think it will turn to that in the future?
Yeah, I think - what it really goes back to Steve is in the prior year in the fiscal year as we were experiencing 14% to 15% decreases over the prior year and we gave the reasons for that being several components one there was an acquisition component from the prior acquisitions that we have done that plague itself out. Second we had this - what we call our A factor as the non-HSA accounts that we are going into the numerator and they were not in the denominator that has an impact. So I think on our last conference call we stated that we expected that those 10% to 15% decrease is where it is going to be coming - we return to more than level we have experienced in past years 5% to 10% decreases. We started to see a little bit of that play out in the fourth quarter as we came down to 11%, partial to that is , we picked out some RA business which was helpful and we also had favorable comparisons to Bancorp acquisition which we have done in the fourth quarter this year, to fourth quarter compared to last year. So we have had a lot of attention to this, we tried to be very open about it, about what we expected would happen and it did happen and now we expect to just we turn more to those normal levels as those other factors are eliminated.
I mean, just little further on that - if you kind of think about it, the fourth quarter, our fourth fiscal quarter sort of between[ph] and it includes one month of new calendar year as well as two months of the prior, it is also true that looking for the prior year, the transaction which contributed to [indiscernible] was intra-quarter in Q4, so if not fairly surprising and I don't think we are surprising you, given how closely you look at this that, kind of the transition from 14% - 15% to more like 5 to 10 that in this kind of transition quarter you would see in a number in the middle of those and that's exactly what you saw.
Thanks and are you seeing - from customers, can you tell us what you are hearing from buyer, from employers and health plans about the upcoming the start of selling season and are you seeing any kind of HR contracting parts where HR kind of thrown by political uncertainty and but want to make commitments in the corresponding signing contracts.
Yeah, so for us the cycle as Steve commented is well under way. This is kind of we - maybe we go little off board in this, but we think of this as mid-cycle not early cycle and I guess I would echo the comments Steve offered earlier that is to say the short answer is no, we don't see in our business any particular pause or hold that we would have - quite the opposite there is a lot of character and lot of signing close activity both at the employer and housing level, we will see how things work out as I commented last quarter, I do think there perhaps was initially post-election a little bit of not so much shell shock specific to our issues but I think we all felt a little bit shocked and so I am sure that affected people but yeah people find their footing and certainly as it relates to what we do, it is clearly more important than ever. So I guess the short answer is no, ultimately we will see how much of that opportunity we can harvest over the course of the reminder of this year. But we feel like the opportunity is certainly there and do so.
Great thank you.
Thank you. That's all the questioners that we have in the queue at this time, so, I would like to turn the call back over to management for closing comments.
Thanks everybody. We very much appreciate the attention. As I said before thank you to our team members and partners for delivering on really solid fiscal 17 and based on the guidance I suspect you all will agree that we are looking forward to an even better fiscal '18. Thank you.
Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program and you may disconnect at this time. Everyone have a great day.
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