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Edited Transcript of HQY earnings conference call or presentation 4-Jun-18 9:00pm GMT

Q1 2019 HealthEquity Inc Earnings Call

Draper Jun 6, 2018 (Thomson StreetEvents) -- Edited Transcript of Healthequity Inc earnings conference call or presentation Monday, June 4, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Darcy G. Mott

HealthEquity, Inc. - Executive VP & CFO

* Jon Kessler

HealthEquity, Inc. - President, CEO & Director

* Richard Putnam

HealthEquity, Inc. - Director IR

* Stephen D. Neeleman

HealthEquity, Inc. - Founder & Vice Chairman

* William Robert Otten

HealthEquity, Inc. - EVP of Sales

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Conference Call Participants

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* Alexander Yearley Draper

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Allen Charles Lutz

BofA Merrill Lynch, Research Division - Associate

* Anne Elizabeth Samuel

JP Morgan Chase & Co, Research Division - Analyst

* Charles Gregory Peters

Raymond James & Associates, Inc., Research Division - Equity Analyst

* Donald Houghton Hooker

KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst

* James John Stockton

Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Research Analyst

* Mark Steven Marcon

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Mohan A. Naidu

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Stephanie J. Demko

* Stephanie July Davis

Citigroup Inc, Research Division - VP & Senior Analyst

* Steven Paul Halper

Cantor Fitzgerald & Co., Research Division - Analyst

* Steven William Wardell

Chardan Capital Markets, LLC, Research Division - Senior Equity Research Analyst

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Presentation

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Operator [1]

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Welcome to HealthEquity's First Quarter 2019 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.

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Richard Putnam, HealthEquity, Inc. - Director IR [2]

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Thank you, Mark. Good afternoon to everyone. Welcome to HealthEquity's first quarter earnings conference call. With me today, we have: Jon Kessler, President and CEO; Dr. Steve Neeleman, Founder and Vice Chair of the Company; Darcy Mott, our Executive Vice President and CFO; and Bill Otten, our Executive Vice President of Sales.

Before I turn the call over to Jon, I would like to remind those participating with us that there is a copy of today's earnings release and accompanying financial information posted on our Investor Relations website at ir.healthequity.com. We also refer to you the usual safe harbor statements concerning the forward-looking statements included in today's earnings release and that will also be made on this conference call with you. They include 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 should -- which could affect those forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause our actual results to differ materially from statements made today. As a result, we caution you against placing undue reliance on these forward-looking statements. We encourage you to review the discussion of these factors and other risk that may affect our future results or the market price of our stock, detailed in our annual report on Form 10-K filed with the SEC on March 28, 2018, along with any other subsequent periodic or current reports filed with the SEC. We are not obligating ourselves to revise or update these forward-looking statements in light of new information or future events.

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

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [3]

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Thank you, Richard, well done. And thank you, everyone, for joining us on this beautiful late spring afternoon for a discussion of the results of our fiscal first quarter of 2019.

Q1 marks the beginning of a new annual sales cycle and that is going to be the focus of our prepared remarks. I will speak to Q1 operating results against our key performance metrics. Darcy will provide a more detailed review of our financial results and guidance. And in between the two of us, Bill Otten, HealthEquity's Executive Vice President of Sales, will describe some of the things we are doing to keep our commitment to outpace market growth this year and into the future. Steve Neeleman is here and will join us during the Q&A following our prepared remarks.

Looking first to the 4 key metrics that drive our business. HealthEquity continued the trend of outperformance on year-over-year measures of profitability and custodial assets on top of robust revenue and HSA member growth. Revenues of $69.9 million were up 26% year-over-year, adjusted EBITDA of $29.6 million was up an even larger 32% year-over-year. Similarly, HSA members at quarter's end reached 3.5 million, up 24% year-over-year, and custodial assets at quarter's end grew to $6.9 billion, up an even larger 31% from a year ago.

Turning to sales. The team got off to a fast start. HealthEquity opened 98,000 new HSAs in the quarter, the most it has ever opened in a Q1 and up 27% over the previous record set in the same period last year. Custodial assets grew by $84 million and were hampered somewhat by declining equity and bond values during the period. These figures do not include any portfolio acquisition activity. During the quarter, however, we were able to enter into an agreement to acquire an additional small portfolio from a credit union and that acquisition is on track to convert to our platform during this quarter and will be included in next quarter's results. This is the first transaction and partnership to leverage the steps that we've taken in recent months to enable credit unions to participate in HealthEquity's depository partner program and we are genuinely pleased to be supporting the credit union movement in a mutually beneficial way.

Custodial cash increased 24% year-over-year to $5.5 billion and custodial investments grew an even faster 75%. And again, that's despite broader market indices that declined between 6% and 8% during the fiscal quarter. So we think that we continue to substantially outpace the market and our largest competitors and believe that we are off to a really good start for fiscal '19.

Last year, on our first quarter call, we introduced you to Bill Otten, our EVP of Sales. Bill outlined last year our sales strategy to continue to grow and outpace the market. And he is again with us here today to provide an update on our sales initiatives and some early insight on the new selling season. Mr. Otten?

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William Robert Otten, HealthEquity, Inc. - EVP of Sales [4]

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Thank you, Jon. In last year's first quarter earnings conference call, I outlined our strategy to continue HealthEquity's record of market share gains. It's a three-pronged effort: Number 1, to play on a bigger portion of the HSA field; number 2, to increase uptake rates within existing health plan and employer partners; and 3, deliver the right information and messaging to our members at the right time to help them connect health and wealth.

Today, I can report that HealthEquity's results this quarter and over the past years show significant progress on each of those efforts. First, our efforts to increase the portion of the HSA field or footprint that we can compete on required building a sales force and support infrastructure that focused on mid-market employers and building out a broader solution offline that would help us to compete for HSAs more effectively through other benefit channels to reach this segment. Our sales force has grown 45% from where it was when I started a year ago, which includes experienced representatives and leaders in the field throughout the country with more to come as we refine the model. We back them by standing up a dedicated lead generation team, a first in HealthEquity. And operating under the banner of connecting health and wealth, we are spinning up targeted digital lead marketing to keep those reps busy. Today, we have a broader solution set for the segment, one that responds to its unique needs. In addition to HSA, HealthEquity now offers FSA and HRA administration to regional employers whether through a health plan, partner or not. Later this year, we expect to add other administrative services for regional employers. And of course, the launch of HealthEquity Retirement Services, our 401(k) plan manager for regional employers gives HealthEquity a whole new way to talk about health and wealth and a whole new audience among retirement plan advisers and consultants, an audience we are quickly learning how to reach. So we're playing on a bigger field with a broader message than at any other time in HealthEquity's history.

Our second front of attack on the market is to drive uptake or penetration rates within our existing partners. We stood up a dedicated team of account executives, focused on growing our largest relationships and circulating best practices throughout our partner base. In FY '18, the team focused on HealthEquity's roughly largest -- 100 largest employer partners. And as previously reported to you, delivered an increase in HSA uptake rates within that group from 24% to 35% during this open enrollment cycle. During this new selling cycle, we're expanding that effort to include about 200 of our largest employer partners and sharing knowledge with the account teams of our health plan partners so they can be experts as well. While we cannot promise the same dramatic impact, we do believe that as employers continue to fine tune their HSA offerings and education, more employees will opt-in to enjoy the value and benefits of HSAs.

Our third mandate was to sharpen the message to help drive members to optimally use their HSAs. When employers select HealthEquity, they are choosing an expert who knows how to drive deep, ongoing HSA engagement and education that meaningfully increases their employees wealth and makes a meaningful impact on their healthcare costs. One recent example of the impact we can have comes from our partnership with one of the nation's premier public institutions of higher learning. Specifically, we suggested several plan design enhancements. We deployed our plan comparison tool to provide personalized contribution and enrollment guidance and we collaborated on a year-round effort to help their members better understand and build long-term savings within their health savings accounts. The results were impressive. In less than a year, the number of investors has grown 56% and the total custodial assets invested more than double, growing 110%. We are uniquely positioned to make a very positive impact on HSA members, their employers and health plan providers in connecting health and wealth as never before.

One final point about this example. When members contribute more to their health equity accounts through payroll, they save, but so do their employers. This is because such contributions reduce the employer's payroll tax base. So the employer in this case was immediately and materially rewarded for its efforts. We still have a lot of work to do in broadening our market coverage, deepening our engagement and penetration rates with our partners and helping build member health savings. But as Jon said, we're off to a great start.

Now, I'll turn the call over to Darcy for comments on the quarter's financial results and our outlook. Darcy?

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [5]

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Thanks, Bill. We will -- 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 first quarter financial results of FY '19 and then I'll provide an update to our guidance for the full fiscal year '19. Revenue for the first quarter grew 26% year-over-year to $69.9 million. Breaking down the revenue into our 3 categories, we continue to see growth in each of service, custodial and interchange revenue during the quarter.

Service revenue grew 10% year-over-year to $24.8 million in the first quarter. Consistent with the strategy we have outlined over the last 5 years, service revenue as a percent of total revenue declined to 36% in the quarter, down from 41% of total revenue that it represented in the first quarter last year, as the custodial revenue stream has become more predominant. Service revenue growth was attributable to a 24% year-over-year increase in average HSAs during the quarter, partially offset by an 11% decrease in service revenue per average HSA.

Remember, HSA service fees are paid primarily by employers on behalf of their employees. And so, by bringing these down over time, we deliver more value and help our network partners deliver more value to their customers. It's working and we are going to keep doing it. As we indicated last quarter, we expect a decrease in service revenue per HSA to be towards the high end of our historical 5% to 10% guidance for FY '19.

Custodial revenue was $28.4 million in the first quarter, representing an increase of 47% year-over-year. Driving factors for this growth were a 31% growth in total custodial assets and a higher annualized interest rate yield on custodial cash assets of 2.04% during the quarter.

Interchange revenue grew 22% in the first quarter to $16.6 million compared to $13.6 million in the first quarter last year. Interchange revenue benefited from the 24% year-over-year increase in average HSAs in the quarter, compared to the first quarter last year with a slight decrease in average spend per HSA.

Gross profit for the first quarter was $44.4 million compared to $33.7 million in the prior year, increasing the gross margin level to 63% in the quarter from 61% in the first quarter last year. The higher gross margin was a result of increasing mix to custodial revenue. We expect that the mix shift will continue over time and will continue to drive gross margin expansion as accounts mature and their balances grow.

Operating expenses were $23.8 million or 34% of revenue compared to $17.8 million or 32% of revenue in the first quarter last year. We expect to continue to invest in sales and technology throughout FY '19. Income from operations was $20.5 million in the first quarter, an increase of 29% year-over-year and generated an income from operations margin of 29% during the quarter. We generated net income of $22.6 million for the first quarter of FY '19 compared to $14 million in the prior year. Our GAAP diluted EPS for the first quarter of FY '19 was $0.36 per share compared to $0.23 per share for the prior year. Excluding stock compensation net of tax and the tax impact of stock option exercises, our non-GAAP net income and net income per share for the first quarter of FY '19 were $19 million and $0.31 per share. Our non-GAAP adjusted EBITDA for the quarter increased 32% to $29.6 million compared to $22.4 million in the prior year. Adjusted EBITDA margin for the quarter was 42%.

Turning to the balance sheet. As of April 30, 2018, we had $270 million of cash, cash equivalents and marketable securities with no outstanding debt.

Turning to guidance for FY '19. Based on where we ended the first quarter of FY '19, we are raising our revenue guidance for FY '19 to a range between $278 million and $284 million. We expect non-GAAP net income to be between $64 million and $68 million. Non-GAAP diluted net income per share between $1 and $1.06 per share. And adjusted EBITDA between $107 million and $111 million. Our non-GAAP diluted net income per share estimate is based on an estimated diluted weighted average shares outstanding of approximately 64 million shares for the year. The outlook for FY '19 assumes a projected statutory income tax rate of approximately 24%.

Before I turn the call back to Jon, I would like to highlight 2 items reflected in our guidance. First, now that all of the new custodial transfers are completed, we expect our interest rate on the custodial cash assets to be at or near the 2.04% reported in this quarter for the rest of FY '19. Second, as we have 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, but this does not include a forecast for stock option exercises for the remainder of the fiscal year.

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

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [6]

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Nailed it, Darcy. Thank you. Our remarks today have focused on sales and account management. And I'd like to close by thanking HealthEquity team members representing us in the field as well as to thank the field teams of our network partners. Our account executives genuinely work their tails off at a difficult job with huge emotional vicissitudes. That's right, vicissitudes. Every day, that's ups and downs. I had to look it up.

Darcy, Steve and I, if it were up to us, they would all be sporting purple blazers every workday. It is not up to us, but all of us as investors should be, and we certainly are, tremendously thankful at how fortunate we are to have what we believe to be the smartest, most experienced, longest tenured team in our business at the point of the spear. So with that, I say to everyone in the field, thank you. And I open up the call to your questions, so long as they are not boneheaded or uncool or dry. Dry?

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [7]

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Boring.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [8]

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Boring. Boring is out. None of those. For those who don't get that reference, maybe Google it. But in any event, operator, we'll take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Greg Peters of Raymond James.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [2]

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Team Purple, can hear me?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [3]

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We can. Everyone else dropped off when they heard the boring thing, and you're here, so.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [4]

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I'm kind of intimidated about the boneheaded, uncool and dry comment. So hopefully I can kick off the -- hopefully I'll be able to kick off your --

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [5]

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This is Jon.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [6]

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All right, well, I'm going to give it a shot here. So I want to spend a minute and I'll ask one question and one follow-up, because I know there's a big line of Q&A. Can you spend a minute and talk about some of the pressures that you guys have over the course of this year that will pressure your adjusted EBITDA margin? Because it seems to be on a nice linear path ward -- upwards, and I know there's investments that you're making and other operational issues that create headwinds there and I thought this would be a good opportunity, just walk us through some of those issues.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [7]

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Darcy?

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [8]

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Sure. One thing that has kind of -- as we've talked about this, we have adopted ASC 606 as of February 1, the beginning of our fiscal year, as most companies had to do in this current year. It really doesn't have any impact on our revenues, per se. It's a revenue recognition standard. But it does have an impact on our sales and marketing expense. And most particularly, our commission expense on sales. In the past, we have paid commission expense to our salespeople as the accounts come in the door, and it's on a cash basis and we accrue it when they come in -- when the accounts arrive. And so, we've had a little bit of unevenness in that, particularly in our fourth quarter when we've recognized the large increase in sales commissions expenses because that's when a big portion of our annual accounts come in the door. With the implementation of ASC 606, what we did is we went back in time as reasonably practical, and we capitalized about $17.5 million of commission expenses and we put it on our balance sheet in other current assets -- in other assets. A small portion of it is in other current assets. That asset will now be amortized over the life of those HSAs relative to when they came on board and it'll be spread over a 15-year life. What that has a tendency to do is that it will smooth out our sales expense throughout the year. And so the $6.9 million that we recorded in sales and marketing expenses in the first quarter, you'll see that, that will be at least at that level, and then it'll grow with a little bit of an upward bend as we go through the year. But you won't -- it will stay pretty stable, and you won't see the big increase that we normally have had in the fourth quarter. Along with that, and included in that number is the amortization of the 606 commission expenses which will be $2 million or less in the current year. But the pickup that we will get from EBITDA is probably about $4 million of the cash that we would've paid out for those commissions in the current year, then that will get capitalized and spread into future periods. And so we have a pickup there, but in addition to that and independent of that, we have determined previously, as Bill has mentioned in his remarks that we have grown our -- not only our sales and marketing team, but also the expenditures that we're doing to go, direct to -- more directly to our employers and to expand our base and to be able to get more HSA sales throughout the marketplace. And so we think that even though we got some uplift from the ASC 606 adoption that we have also determined independently from that, that we're going to invest in our sales opportunities and expand it. So I think that's one area of pressure, self-imposed, so to speak, on our EBITDA margins. They're, as you know, they're very healthy and we think that they, long-term, can become even healthier if we'll take some time now to spend a little bit more money, not only our sales and marketing efforts but also on our technology platform. We've always continued to invest in our technology platform to be able to differentiate and to have a platform that is the best in the industry for not only managing health savings accounts, but also helping our members to navigate it better and to have the tools that will help them become better savers in the future.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [9]

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Yes, Greg, I -- just add one comment to that, which is, we felt -- we've always said to you that we want to have the opportunity to increase profit margins but we're willing to spend where -- particularly in sales and marketing, where we can generate attractive returns for our shareholders. And this is a case where we can. And so it's fortunate that coincident with ASC 606, that the result is we get sort of the best of both worlds, we get increased margins and we can incrementally increase what we're spending in current cash on sales and marketing activities. And that latter point is really the result of the fact that we feel pretty excited about what we saw last year, and what we've seen in the pipeline so far this year, and that's reflected in the Q1 results. And we feel like it's a good bet to increase the headcount that we have out in the field. And as Bill has talked about some of the other things that we're doing, both with our -- with new prospects and then also on the account executive side, working to share expertise with our existing customers, to drive uptake. So this is a case where you've said to us, and as have others, if you think it's worth it, go ahead and spend. And we think it's worth it, so that's what we're doing. And that again reflects a view on our part that there is incremental opportunity out there to go get, and to go get in a way that's really valuable to shareholders.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [10]

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Just to follow up on that point, especially regarding the build-out of the sales initiative. When you obviously are thinking about your business more than just in a 1-year or 3-year outlook, but obviously, you put together a plan that I imagine is going to include a lot of investment over sales and marketing over the next several years. And I'm just wondering, how you think about budgeting that and how you're making sure that you're getting an appropriate return on your investment there?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [11]

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Well, one -- I'll say, one challenge that I think your question points to is the good side of recurring revenue is that it recurs. The flip side is that none of it happens until you've made the sale. And at then, and even then, it happens in small amounts. So for the most part, the incremental spending that we are doing in the current year will not have an impact on current year revenues. There'll presumably be some impact as we get later in the year, but a lot of that ramp will really come next year. So similarly, what you're seeing this year in part is a result of the ramping that we began to do last year. So that's something we have to keep in mind. But as you say, within that context, we look at these dollars sort of from an IRR perspective. Ultimately, we're looking at what's our return over a reasonable period of time. How do we make sure we manage the business so these are truly incremental dollars, we're not mixing inadvertently sales activities with service activities, so that at some point you don't really know what your incremental profitability is. And those are things we're pretty careful about. It's the same analysis that we do in the context of M&A, I suppose, but with a little less -- always a little less clarity about the results. But that's kind of how we look at it, where we really try not to say, well we have to have payback this year for sales and marketing expense, but we certainly want to see payback soon and we want to see it meet the thresholds that we know that our investors have for their capital and more. So that's kind of how we look at it.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [12]

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And the second topic I wanted to just briefly have you comment on would be around the custodial revenue aspect of your business and the competitive conditions in the marketplace. It seems like there's a growing number of your competitors that have earned or won the non-bank custodial designation. And I'm just curious, if you're thinking about that, in the context of your continuing growth that there might be any pressure on the rates that you're getting from your bank partners, et cetera, as we think about this going forward?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [13]

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Yes. Well, I will say this. Demand for deposits has gotten extraordinarily healthy, certainly in the last 6 to 12 months and you see that in the rates that we're getting and so forth. I guess, generally, here's the way that I think about your question. I mean, we pioneered this custodial model. It's been more than a dozen years now, and it's now being adopted, as you say, by a number of our competitors and we think that's good for the industry. We thought it was the right model then. Others have had different views over time. But it seems like people are kind of coming around, and -- but over that period of time Greg, we haven't been sitting around, and I know you know this, sitting around doing nothing. We've built, I think really sophisticated and proprietary, both technology and business process, really the goal of which is to deliver certainty and precision to our depository partners, clarity to the regulators involved in all this, and most importantly, security for our account members. And we've built an ecosystem of depository relationships that includes, now includes as I mentioned in my upfront comments, credit unions as well as banks, and these are long-term partnerships on which these institutions can rely and build asset portfolios around on their end. We've created liquid products for members that want higher interest rates, but with the convenience of card swipe, as I think you know. And of course, sort of on the investment side, we've tried to really lead the industry in bringing HSA-focused investment advice to members, adopting low-cost fund lineups, being absolutely transparent about fees, while others kind of scream for exemptions from rules that would've required that. So I guess, when we look at it, Greg is, we will keep looking for ways to add more value than the next guy to the relationships that we bring to our entire ecosystem, whether that's our members on one end of that, or our depository partners on the other. And I think we've done that successfully to date. We listen very carefully to what our depository partners are looking for, and we try to get it to them as much as we can. So that's kind of going to continue to be our competitive advantage there, I think.

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Charles Gregory Peters, Raymond James & Associates, Inc., Research Division - Equity Analyst [14]

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Excellent. Can you just update me, what was the number of depository partners you had at the end of the first quarter?

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [15]

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It's either 12 or 13, right in there.

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Operator [16]

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And our next question comes from the line of Anne Samuel from JPMorgan.

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Anne Elizabeth Samuel, JP Morgan Chase & Co, Research Division - Analyst [17]

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You spoke to the acquisition of a small credit union portfolio. As we move throughout the year, how are you thinking about incremental opportunities for M&A and how that market looks?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [18]

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As we've said all along, we're just going to kind of be opportunistic about this. We don't have a quota or anything along those lines, but we do have an active pipeline. And we genuinely believe that we are an acquirer of choice, both because we kind of know how to do this, we've done it a number of times now, and also because of our record from a service perspective, and our ability to deliver some innovation to the members and the employers and the like, tends to mean that it puts the seller of the portfolio in a favorable light. The other thing that I'd note that we've kind of added here is a little more ability to be granular with regard to our deposit partner program, so that if it's of interest, that, no pun intended, that our sellers of these portfolios can become participants in our depository partners program and that can meet some of their needs in many ways better than the HSA business might have. So that's kind of like how we're looking at it. We certainly will continue to try and do these portfolio acquisitions. They work great. They're, as you know -- and they're, they deliver, we think very, very nice returns to our shareholders, grow our base, leverage the technology and operations footprint we already have. And we like them. We like serving more people and helping more people build up savings and this is one way to expand that footprint. And so we'll keep doing it. But we don't have a quota or the like and certainly our guidance doesn't reflect incremental acquisition activity.

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Operator [19]

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And our next question comes from the line of Jamie Stockton with Wells Fargo.

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James John Stockton, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Research Analyst [20]

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I guess, maybe the -- so the first one, in Bill's comments, I think he made a reference to HRAs and FSAs and the potential to add other services. It seemed like maybe that was a little more overt than what I've heard previously, and I'm just curious if you have any color on, hey, this other stuff is -- this part of our business today, but we really think that it could grow disproportionately to become a bigger part over time. Is -- are we starting to hear maybe some initial hints of that from you guys?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [21]

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You got that, Bill?

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William Robert Otten, HealthEquity, Inc. - EVP of Sales [22]

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Sure, yes. Thanks, Jamie. Really what I was referring to in my comments is, we're starting to bring some of the services that we've traditionally offered on the upper end of our market, the large clients, down to more of the mid-market clients, where we've specifically focused on a smaller set of services. So we're -- it's very -- it's too early to tell right now. We've just started doing it recently. But certainly, the interest is there to bring some of those services down market. As I mentioned, the FSA and the HRA product.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [23]

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Yes, and I mean, Jamie, I think partly where your question's going is just, we have a, we certainly have -- this is an area where we've been doing research for some time. And we have a view as to what the employers and benefits advisers and the like in this part of the market really want to see, particularly for those employers, they're not necessarily on a trajectory to go full replace HSA and we think we can do a great job of delivering that. And one of the nice things about it is, it allows us to meet health savers at different places on sort of that continuing with health savings. So someone using a flex account is a health saver. They're just earlier on in that process. And we can help them just as we might help the person who's looking for investment advice and bring some of that same consumer focus to that product. So that's -- I think it's something that we've done for a long time at the high-end of our business, but we're now bringing that into the middle market. And then, as Bill suggested, we do have some other things in the pipe, but we're not going to tell you what they are today, because it's not our WWDC, it's Apple's. We don't want to [step on their toes], you know what I mean?

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James John Stockton, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Research Analyst [24]

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There you go. And maybe just one other question on custodial revenue, on the flip side, if we think about COGS for that revenue line. Regardless, you've seen rates go up a fair amount, can you just talk through how you guys think about the rate that you're going to have to pay to be the account holders on the cash, and how that might evolve over time?

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [25]

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Yes. The way that we view this is that it'll be market-driven. Remember that these are HSA balances have an average of less than $2,000 in it. So think of it, for somebody who's using this actively, they're paying medical bills out of it, they might be building their savings a little bit. But it's kind of like an interest rate you would pay on a checking account. What we do and all of our competitors of note have a tiered rate schedule, whereas if they do become a saver and they want to keep more in cash, then they'll get a little bit more yield on their cash, and we'll see how that goes. We'll pay attention to it closely in the marketplace. And we've been in this space before, 10 years ago, when interest rates, when the fed rate was over 5% or 11 years ago, I guess. There was a higher interest rate paid but as rates came down, I think people learned that these are fairly inelastic, but we'll be very cognizant in watching for any demand there, as it relates to interest that we pay.

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Operator [26]

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And our next question comes from the line of Mark Marcon from R. W. Baird.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [27]

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I was wondering, could you provide a little bit more color with regards to the source of the account wins? As they came on, this was a record first quarter. How much of that was from like new employer partners versus existing accounts that basically had broader adoption? Anything that you could give us there? And what does that portend for the next few quarters, do you think, prior to the big fall selling season?

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [28]

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Yes. Normally in our first, second and third quarters, Mark, as you know, most of our growth in the accounts that occurs comes from our health plan channels or our partners that are bringing us access to the smaller employers. And so generally, that would be -- we did have 1 employer who normally we would get in the enrollment cycle in the December/January timeframe. They came on board for about 10,000 accounts and we got that in the quarter. So if you took all that out, then the rest of it was probably -- is still pretty healthy, but came from our normal, smaller employers and our health plans. Now as Bill says, as we continue to work with these smaller employers, we probably expect to see over time that we'll start getting more of those throughout the year than just always at the year-end enrollment. But I don't think that we've seen anything noteworthy in that regard this year. But we did have one employer that was probably more of a year-end type employer that came on board.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [29]

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Great. And then, with regards to the sales initiatives, can you talk a bit more there in -- with regards to what the opportunity, from a nearer term perspective, seems to be in terms of broadening the scope of services that you're providing to the smaller employers in terms of including HRAs and FSAs and some other administrative services that will be named later? How should we think about that in terms of broadening the addressable market that you can immediately go after, and that the sales force is capable of reaching?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [30]

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Yes. A couple of thoughts. I mean, first of all, as Bill said, and I'll put an even finer point on it, this is about reaching a portion of the market where we just weren't on field and Bill commented on this a year ago, and that...

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31]

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I'm trying to figure out how big that field is, Jon.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [32]

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Well, it's -- fair enough. I mean, it's -- the answer is, obviously if it had been huge from the outset, we'd had been there. But what we thought was that these accounts were being or would be soaked up as these parts of the market start to grow, going to be soaked up by the health plan channels, it's just that the data told us otherwise. And so that's kind of -- so that's the first point I'd make. And again, I think we'll have to see in terms of size and so forth. The second point I'd make though is, when you think about the other services we're providing, what I want you to realize is the purpose of providing those services isn't really from our perspective, to expand our TAM. I mean, we believe that the core market we're in is still in its relatively early innings. And we can find no other market, frankly, with the same growth opportunities as our core market. But what we are very cognizant of is that, it's helpful in terms of driving our core business, to offer some other services. And that's always been true. It's just more true as we enter a greater diversity of market segments. So I think it's fair to think a little bit about TAM and so forth, maybe some of this stuff over the next few years has an impact on service fees or what have you, but the core objective really is to put the company in a position to win when it comes to the HSA market which is, of all of these related services, has the largest potential, is growing the quickest and we think is the most durable in terms of the relationships that you establish with consumers. So that's the way to think about all of this is, is it's all about positioning to grow that core business. And even when we think about what we're doing for example, in the 401(k) space, we're not getting into the business of 401(k) plan record-keeping. We're trying to be in the business of managing an employer's 401(k) and HSA product so that a complete picture of health and retirement savings can be presented to members, because we know, if that's the case, those members are going to use the HSA more and they're going to use it as it is intended to be used. So even there, while absolutely there's some revenue produced on the other side, our real goal there is, is we know that if you present the complete picture to the consumer, we know what the consumer does. So everything we're doing is really about, I think, growing the core and growing our business, our market presence within the core, better than anybody else. And that's the commitment we've made to you. So I think for those who might say, oh, I suppose the bad news is I'm not suggesting there's a bunch of additive TAM. The good news is, there isn't a need for a bunch of additive TAM. We are extremely confident in the long-term prospects for the core market we're in.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [33]

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And when I was getting to the additional TAM was more along the lines of the smaller type accounts that you weren't previously going after. Because I do appreciate that you're focused on the core and the HSAs and that is --

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [34]

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Well, and I think that's right. I mean, there, I'd say, think of it this way. If you were a small employer and your -- we might have thought years ago -- or even 3 years or 4 years ago -- that unless we were partnered with your carrier, we couldn't get to you. And it turns out, that's just not the case. That is to say that this is one area where we have done proprietary research over a long enough period of time that we now know that you as an employer can be receptive to what we're doing. And in particular, that is in part because you as an employer and your benefits adviser want to be able to shop that health plan relationship every year. And as you know, Mark, that the HSAs are pretty sticky in terms of how you move them from provider to provider, just the mechanics of doing it. And so in fact, if you actually look at it, the smaller an employer is, the less likely they are to have purchased the HSA through their health plan. And that was a very counterintuitive result for us but that really triggered our investment in this area. So thinking about the opportunity here, keep in mind that these are markets that relative, whereas, as a large group, certainly in the enterprise segment, we start to hear people say, well, about half of the employers at least offer an HSA and so there isn't as much greenfield, et cetera, et cetera. Here, your penetration rates are still very low. Now there are barriers to penetration, not the least of which is that -- it's still the case that there's a little bit of an issue where these products have lower premiums and to some extent, you're fully insured and so you're -- there's a little bit less of an interest on the part of the brokers and whatnot and selling them that remains true, it's sort of the carriers. But nonetheless, they're growing. And so we think that this end of the market is less penetrated certainly than the enterprise. And therefore, the greenfield opportunities are bigger. And what's also nice is that more often than not, with the smaller groups, if they go HSA, everyone's going HSA. And so you're getting full replaced and that's pretty valuable for us, too. So look, I don't have a direct answer for you in terms of what the actual result would be because I don't have a crystal ball about the pace of penetration by segment. But we certainly think the opportunity's there and we're delighted that this is an opportunity that we can now attack from, not just from really from 3 directions now. We can attack it from the perspective of the health plans as we always have, we can attack it by providing a bundle of services directly and in partnership with advisers and the like and we can attack it from the retirement end through the work that Bill talked about that we're increasingly doing with financial advisers. So we think that's pretty cool and we'll see how it goes.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [35]

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That's great. One last one, just on the credit unions. Can you talk a little bit about the cost of -- I know it's early, but in terms of when you think about buying a portfolio or getting a portfolio transitioned over, how should we think about that?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [36]

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This is one of the great things about these transactions, is -- and a lot of credit goes to our service and implementation teams in this regard as well as our transaction team. The process for moving these portfolios over is extremely smooth. We were able to do it in a number of months, not quarters and in a way that is minimally disruptive to members, certainly provides no disruption or cost to the selling provider and can make them feel good about the decisions they're making. So the costs are really modest. I think what's -- we haven't heard some kind of onetime costs and making some adjustments to how we communicate things and also to the way that our sort of cash program works to accommodate the specific needs of the credit union world, making sure that people understand that. Their deposits may be NCUA insured and making sure that NCUA is comfortable with what we're doing. Those kinds of things. But with those costs incurred, they are very similar. I think the thing that is different about [CEUs] is that they take tremendous -- and I think this is true of all institutions, but particularly these. They take tremendous, tremendous pride in their relationships with not only individuals but with local businesses. And so we're fortunate in Utah to be in a state that has a very, very large credit union footprint and we see that every day and so we think there's a real opportunity to leverage that, and we'll see how it goes, but we're proud to be both in the position of being an acquirer there but also in a position of being a supplier of cash for lending to credit unions as well. And so that's something new for our industry. And certainly for us, it's still pretty good.

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Operator [37]

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Our next question comes the line of Stephanie Demko from Citi.

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Stephanie J. Demko, [38]

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So just given the buildup that you guys have of cash on your balance sheet, kind of the shrinking size of portfolios that are available for purchase, I wanted to ask if you would ever consider acquiring an HSA platform competitor versus solely going up for an HSA portfolio? And if so, how we could think about the synergies just given a lot of these other players kind of outsource their platform and you'd be able to leverage your in-house platform?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [39]

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Man, who is the evil genius now, Stephanie?

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Stephanie July Davis, Citigroup Inc, Research Division - VP & Senior Analyst [40]

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Been doing some noodling on it.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [41]

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As my kids say, he may be an evil genius dad, you're just evil. But I'm sure he's not evil, by the way, in case he or anyone from the firm is listening. Probably not. Just because he's digging a hole to the center of the earth doesn't mean he's Dr. Evil. But -- so -- I mean, the answer is -- I think that's something -- we certainly look at these kinds of businesses. And I think perhaps what you're referencing is that there have been news reports that one of the platforms that's used by some of our competitors, I suppose, is on the block and I'm not going to comment on specific M&A activities, of course. But the way that we would look at that is, can we bring incremental functionality to our existing customers and can we reach new customers as a result of that kind of a transaction. So, for example, if we thought that a transaction along those lines would allow us to be more valuable a partner to our health plans or to employers or to reach new channels that might have an interest, that's certainly something that we would definitely look at and I think pursue aggressively. And certainly if we did pursue something like that, we would be in as good a position as anyone, perhaps better, to be able to provide value to the would-be sellers and still deliver a tremendous value to our shareholders because we do -- certainly, there would likely be a significant amount of synergies on the cost side, but I think more importantly, on the revenue side. A lot of these types of products that you see out there really haven't taken full advantage of the economics of an HSA, particularly -- we're talking about private companies where they maybe didn't have the balance sheet to do that, that kind of thing. So certainly that's the kind of stuff that we'd look at. Again, without commenting on anything in particular, if we thought it added value, if you were buying a platform just for the purposes of getting the customers, there probably is someone else who would be willing to pay more for that platform because they thought that now would be a great time to enter the business. And I can't argue with a logic that it's a great business to be in. But that would be -- that wouldn't be as interesting to us and, certainly, I would imagine that there would be better acquirers for something that was solely for the purpose of just adding more customers in that circumstance.

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Stephanie July Davis, Citigroup Inc, Research Division - VP & Senior Analyst [42]

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Understood. So without being too specific, are there any particular capabilities you could think of that would be more interesting to you?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [43]

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That is a bonehead question. Next. I think I'm going to hold off on that. I mean, there are a lot of things that our platform does really well. I guess, I'll say only that there are always things that either competitors or quasi-competitors do better because they've had to focus on those things. I mean, that's sort of the nature, that's the beauty of competition is it does really lead people to specialize in particular aspects of the service. So it wouldn't surprise me that we would find some things that would be really valuable in looking at some of the folks who sort of ply this business from more of a, let's call it, services and software type perspective. And ultimately, I'll say this. Another point is that we expect over the long period -- over the long haul that the real value of a lot of what we do from a platform perspective, and I've said this before, the administrative side of this is kind of table stakes at some level. What's really valuable is the ability to, as Bill said earlier, is to get information to consumers, the right message, the right time, the right content, and to use everything you know about a consumer to make that happen. And whether that information is valuable for the purposes of helping them build health savings or advance what they're doing on the retirement side, or even to use their health benefits to the fullest to spend less today or to stay healthier, those are -- that's a really, really valuable thing and that is going to require investment over time. And in the analytics, of course, but also in all the infrastructure and data infrastructure that's around that. And so the ability to do that over a wider base of business is certainly something that we would consider valuable along with the ability to really use that breadth to push innovation in the industry. From our perspective, what we have found is innovation is our friend. We're -- as a sort of, for lack of a better term, specialized player, when we push innovation, it takes our competitors off their game, not because they're not innovating in their own ways but they just aren't quite as focused on this industry as we are. So the ability to innovate across a wider base, all those kinds of things, are always valuable things we're looking for. So all those are the kinds of things that would play in, but I'm not going to give you a feature want list.

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Stephanie July Davis, Citigroup Inc, Research Division - VP & Senior Analyst [44]

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All right, understood. Thank you for the color either way. And then one quick follow-up just because we do have Bill on the line. Just given the recent discounting strategy, obvious it's early days, but is it possible you can update how it's kind of helping new wins in the quarter?

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Unidentified Company Representative, [45]

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Discounting.

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William Robert Otten, HealthEquity, Inc. - EVP of Sales [46]

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Well, price discounting?

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Stephanie July Davis, Citigroup Inc, Research Division - VP & Senior Analyst [47]

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Just on the greater discounting on your services?

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William Robert Otten, HealthEquity, Inc. - EVP of Sales [48]

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Sure. Yes. I will tell you, Stephanie. First of all, we are a value-add product to the service. We're not out looking to be the least expensive. However, when it comes down to competing, we also don't want to lose deals on price. So as we looking to bring in more employers and increase the AUM, we will get competitive where needed with Darcy's help and the pricing team. So yes, it absolutely does help. But we don't always go in expecting to be the lowest priced provider.

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Operator [49]

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Our next question comes from Steve Halper with Cantor Fitzgerald.

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Steven Paul Halper, Cantor Fitzgerald & Co., Research Division - Analyst [50]

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Just a housekeeping item. You had a tax benefit in the quarter, what drove that? And I'm assuming -- you said 24% for the rest of the year, so I'm assuming a higher effective tax rate for the remaining 3 quarters, is that fair?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [51]

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Yes, well, to answer the first question and that will help answer the second question. The credit that we got on a tax -- for the first quarter is a result of stock option exercises that occurred in the first quarter, so that would be from February 1 through April 30. And under the new accounting rules, we get -- we take the benefit of that into our provision. It used to just go to the balance sheet and now it goes through our provision. So to the extent that, that -- those stocks -- the gains that people got off of those stock option exercises exceeded our pretax income then we took the credit and we got the benefit of that. We do, as I said in my comments, we do not forecast what those stock option exercises will be going forward. So if there was 0, and our pretax income from Q2, Q3 and Q4 were whatever it is, then we would expect the normal tax rate to be 24% on that. And so that's how we're modeling it. That's why we do our non-GAAP EPS calculation because it kind of backs out the necessity of trying to predict what that's going to be because it's virtually impossible to predict. (inaudible)

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Steven Paul Halper, Cantor Fitzgerald & Co., Research Division - Analyst [52]

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Right. So if it's 0, so for a quarter, do we assume 24% or [24%]?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [53]

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Yes. But it will be blended. So in our Q that will be filed later this year, there will be a reconciliation. And you'll see how much of that was a result of that tax benefit. And so that we'll -- whatever we got in the first quarter, we get that for the rest of the year. But if you look at it on a quarter-by-quarter basis, we're assuming the 24% tax rate for the future quarters, that's correct.

Would it be fair to say, Darcy, just to be clear on this, that when we give the guidance of 24%, that guidance is for the full year inclusive of Q1 and it is ignoring the tax effect of stock options.

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [54]

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Not a stock option, stock option exercise.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [55]

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Stock option exercise.

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [56]

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Correct, that's correct.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [57]

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So it's not that it's 24% for the rest of the year, it's 24% for the full year but ignoring this effect.

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Steven Paul Halper, Cantor Fitzgerald & Co., Research Division - Analyst [58]

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Right. So a normalized year would have been 24%, so we assume -- since you can't forecast that in the quarters, we just assumed 24% and you get that credit net at the end of the year anyway. So it will wind up being less because you just can't forecast it. I get it.

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [59]

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That's exactly right.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [60]

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It's another victory for opaque accounting.

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Operator [61]

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And our next question comes from the line of Donald Hooker from KeyBanc.

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Donald Houghton Hooker, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [62]

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I may risk asking a boneheaded question here, but did you guys talk about how big that (inaudible) --

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [63]

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Yes, Halper's one of those short-sellers, so we got that -- we got through him, so you're all good.

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Donald Houghton Hooker, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [64]

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All right. So you mentioned you did a small tuck-in acquisition. I understand it's small, but were there any numbers that you supplied around what that's adding to your guidance?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [65]

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No, we haven't.

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [66]

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Well, yes, it's about $10 million of AUM and it will be a purchase price of around $1 million. So [it's relatively small].

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Donald Houghton Hooker, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [67]

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Okay, got you. And then I'd say, look, I think about interest rates are creeping up, what are the scenarios that would cause -- and I understand you placed a lot of the money already that you've gotten for this enrollment year. But are there scenarios -- what is the potential for more upward creeping of interest rates during this current fiscal year? I know that's not normal, but in prior years, there are, sometimes things come up where rates can trend higher during the year. Kind of what are some of the scenarios that can drive your yields on custodial cash up during the year?

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [68]

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Yes. Well, I mean, thanks Don. Last year, we had an unusual circumstance where we had 1 of our depositories who had a very low rate contract who decided to pull out of it and they did at midyear. So that money got placed elsewhere at prevailing rates at that point in time. So we got kind of an unusual uptick midyear last year as a result of that. Generally, that's not the case. You might see -- if we got new money come in more than the capacity of what we've got right now and we entered into another contract, I mean, you could see a little bit of an uplift but that's more of a rebalancing issue amongst our current contracts which we typically don't do. We kind of go pretty steady as she goes. The benefit of the rate increases or whatever, will most definitely favor us when we go to enter into our new depository agreements that will come up primarily towards the end of the year, in the December/January time frame. So we'll get pick up there. And it's for whatever portion of the contracts roll off and get replaced with new money or just new money coming in, in and of itself, getting placed newly. I haven't looked at it recently. There may be a couple of smaller contracts that may turn during the year but they're not hugely significant. Most of it will occur at the end of the year.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [69]

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I just want to put an emphasis on this point because I think it's -- in years before last, this was generally pretty steady over the course of the year. We try to manage it to steadiness over the course of the year. Granted, the total is bigger so small amounts of variability, whatever. But we've given guidance of -- in this call, of kind of being around the 2.0 something number for the remainder of the year, essentially where we were in the first quarter and we mean it. So that's definitely something to pay attention to and we would encourage someone who would want to draw lessons from last year to, again, keep Darcy's comments in mind and say there were reasons why and reasons we talked about on these calls, why we had this kind of midyear significant upslope in these things. Now we're prepared for that and we would love to have that happy circumstance again, but it's not something we're expecting or forecasting. So take us at our word on our current assessment of where rates will be.

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Operator [70]

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And our next question comes from the line of Sandy Draper from SunTrust.

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Alexander Yearley Draper, SunTrust Robinson Humphrey, Inc., Research Division - MD [71]

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So most of my questions have been asked and answered. But maybe just one quick one for Darcy. Makes sense that the gross margin is down on the service fees as you're discounting there. But just thoughts in terms of the longer-term trend. Is that, I would assume, if you continue to see some longer-term declines in the service fee per account, you would expect to see the gross margin decline and is there a place where you think that sort of levels out?

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [72]

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Yes, the way we evaluate it, I think I talked about this before, is that we look at that as one of the components, but we really look at the profitability of an HSA on a -- across all sources of revenue: custodial, service and interchange. And I've always used this example. If an employer comes to me and says, you know what, I'm going to adopt HSAs, I actually have some existing HSAs, I want to move those dollars to your platform and I'm going to make a heavy employer contribution to help fund these accounts and I'm going to train my employees and help them figure out how these are not just spending accounts, these are actually long-term savings accounts for retirements, they should be putting more money into them and they really do a good job there. I am going to give that employer a lower account fee. I just am. And if that means that my "service margin" for those accounts looks like it went down, yet my custodial margin and my custodial revenue goes up significantly, I will do that all day long. And so we try to evaluate it not just looking at the service revenue and the service costs component of it and look at the account as it appears in totality. Now that being said, we will continue to do what we've been doing. By design, our service revenues are going to come down over time. We've used this 5% to 10% target for a long period of time. It seems to fall within that band and it's not because we're getting priced that way in the marketplace so much as it is that's the incentive that we've offered to our trading partners, to our health plans and to our employers. If you bring us more cash, you're going to get a lower account fee. And we will try to be -- we're always looking for better ways to service our employers in a more cost-effective and beneficial way. And there's some you can do there. But it does cost money to service these accounts because of our high-touch 24/7 call center and being with them for -- if they're at the emergency room on a Saturday night and they need to figure out how they're going to pay their bill, we'll have somebody answer the phone for them. So there are service costs that are associated with that. We try to always be smarter and do a little bit better. But if a little bit of that margin sacrifices because we're helping people build their health savings then we'll continue to do that.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [73]

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I just add there, Sandy. We were -- I was quite pleased with the team's performance in terms of -- certainly on a sequential basis of the sort of service COGS. And we talked about early in the year that we felt we got off to a really good start with regard to service levels during January. They were outstanding. And I think that's something that's probably helped build an [appeal sale]. It's always good when peoples' immediate service experience with you has been really good and we just had really good service levels in January. But also meant that we had more people than we probably needed at that point. And the team did a nice job of kind of keeping the best but not just keeping bodies around to keep bodies around. So that reflected itself in actual service costs. And at the same time, if you look at revenues holistically, this is the second first quarter in a row where revenue on a total -- in totality on a unit basis is going up. And so the result of all that is if you look at EBITDA per unit or what have you, that number is getting wider and wider and that seems like a good thing. So we're not going to get too hyped up over 1 component of revenue or cost but it is worth noting that one of the things that contributed to really strong margin performance this quarter was on the service side, the team followed up January with an excellent first quarter from a service perspective but also from a cost control perspective.

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Alexander Yearley Draper, SunTrust Robinson Humphrey, Inc., Research Division - MD [74]

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Got it. That's really helpful. That certainly makes a lot of sense looking at the account on a totality basis. And maybe one final one, and it's maybe for you, Jon, or for Bill. I know you don't like to call out specifically competitors. But when you think about the competitive landscape in buckets, has there been any change in terms of when you think about who you're seeing more or less in terms of the payers with their own HSA providers, other standalone players, the more broader benefits, back office type [groups] has there been any significant change in terms of sort of the different broad groups of who's competing more or less effectively?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [75]

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You want to hit the buckets, and give your observation.

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [76]

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Sure. So I would say, we're not seeing anybody that we haven't seen in the past before. We do see different competitors that come at it from a different approach, depending on what their area of expertise is. But no, I can't say that we're seeing any additional competitor that's doing anything that they weren't doing last year.

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Operator [77]

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Our next question comes from the line of Mohan Naidu of Oppenheimer.

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Mohan A. Naidu, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [78]

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Maybe I'll add a dry one here. For Steve, you're awfully silent there. Anything to expect from DC from the several bills that are supposed to happen but never seem to happen?

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Stephen D. Neeleman, HealthEquity, Inc. - Founder & Vice Chairman [79]

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I will say we're pleased with the direction of the discussion. There, by our account, it's a couple dozen bills that, these are coming from the both sides of the aisle that now are supportive of health savings accounts. So I think we're the kind of beyond the period of time where it seems to be kind of a Republican versus Democrat division when it came to supporting health savings accounts. But that being said, we can't guarantee any of this is going to go (inaudible). There's been some talk of late, that there's going to be one last push for kind of the ACA reform and you know that if that comes, there will be a lot of [expansion] opportunities, and those kind of focused on the big 3 we talked about for a long time, which is increasing the amount that people could put into their HSAs up to really double what they can now or even more, the out-of-pocket max, and then allowing for these chronic care provisions, and then also HSAs for working seniors. It's been way too long that seniors that are still working can't contribute to their HSAs. So, look, we're positive where it's gone. We love the fact that every piece is significant, every bill that gets out, that's getting out there has HSA expansion. Now, we're just waiting for it to occur. So if you've got any more insight, let us know. But we're following it closely.

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Operator [80]

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Our next question comes from line of Allen Lutz from Bank of America.

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Allen Charles Lutz, BofA Merrill Lynch, Research Division - Associate [81]

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So the question for Jon and Bill, this is a market growth question. Your custodial cash is basically growing at the same rate that it was last year, but the market's expected to slow. You guys are taking more share than last year. So I guess, a, is that the case? And then b, if portfolio acquisitions are slowing, where are you guys growing faster than you were last year?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [82]

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So I think the first part of your question is, are we taking share and the short answer is yes. One way to look at that is if you looked at -- and this is using the Devenir data, so take it for what it is. But we added -- looking at the last calendar year, we added roughly, I don't know, $1.7 billion or $1.8 billion of assets, according to Devenir. And our nearest competitor added $1.2 billion or 2, 3, something like that and it went down pretty quickly from there. So clearly, we are out there taking share whether that's expressed in terms of accounts or assets, and that's a good thing. I don't think we said that the pace of acquisition is going to slow either organic or accretive -- or acquisitive but just that we're not going to try and price things into the business on an acquisition basis to meet some kind of quota in that regard. So I guess, I'd leave Bill to comment on where we try to take share from except -- I'm hoping the answer is everybody.

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William Robert Otten, HealthEquity, Inc. - EVP of Sales [83]

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No, it's a great question and Jon's absolutely right. We're out there fighting the good fight every day. But one of the areas that we're also able to get account growth is with the existing employers we have now. As we said before, we've been able to spend time with those large employers and get them to roll out more education programs, increase adoption. And so while we're out there fighting for all the new business we can get every day, we're also spending time with our existing clients to make sure that they're getting the levels of adoption that they want and we want.

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Allen Charles Lutz, BofA Merrill Lynch, Research Division - Associate [84]

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Got it, that's helpful. And then a follow up on rising interest rates. I think that you guys have said the average duration is in this 3- to 4-year ballpark. I guess, since year-to-date interest rates at the front end of the curve have really moved up quickly, have you guys thought about when you were renewing these contracts, getting into shorter duration contracts you could more quickly benefit from rising interest rates? And if you have, have you started to do that yet?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [85]

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Yes, one thing that we've tried to do from the get-go, since these kind of come in sporadically throughout the year is to -- it used to be that we had a lot fewer depositories and so it was a little bit more difficult. But we really are trying to deliver a consistent, steady results to the marketplace that are not only somewhat predictable but also that they ladder out so we don't get spikes at one point in time, and it won't take some short-term benefit that is going to help us in the short term. So when we ladder it out, we are going to continually to ladder it out over generally a five-year period and so that we don't get hit with 1 duration or a short duration or a long-duration in any 1 particular quarter or period. We just think that that's a healthy view of how to look at this and how to place funds out over a period of time and we like the steadiness of it. So we'll take advantage of it when it arises but when we place new money, we'll ladder it out and we'll do what we think is best for the business but also try to deliver that consistency on the revenue line.

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William Robert Otten, HealthEquity, Inc. - EVP of Sales [86]

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Yes. And I just want to make sure you're thinking about this one right. Our average -- for lack of a better term, the investment policy in this regard is that we could have an average duration of between 3 and 5 years. In practice, while the ladder may go out that far, our average duration tends to be right around that -- the shortest end of that, around 3 years. And in fact, depending of the time of year, can even be a little shorter than that just because of the fact that funds aren't deployed evenly over the course of the year. And so we've kind of done that job of coming in to the extent we can. And it's certainly something we think about, that is to say, that we really want to deliver stability more than anything else in this regard. There's not -- I don't think you're looking for us to deliver that last 5 basis points in exchange for more volatility and there are lots of other ways one could play that than this. So that is kind of our goal and it is the way we think about it. But we're kind of at the short end in terms of average duration of where we could be on our current policy and depending on the way the -- we mostly think about that in terms of what our liquidity needs are and all that kind of stuff. But certainly, if stability was served by coming in even further we'd look to amend the investment policy and we'd probably tell you we were doing that.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [87]

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Yes, and as we go through the year, as Jon says, just by definition, a 3 year becomes a 2-year duration as you go through the year. And so that gets shortened up on us automatically as we go through that and then we take that into account when we replace that money.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [88]

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The other thing we are trying to do more of is, and this does sort of implicitly affect duration is one thing we really feel like we are uniquely able to deliver as among large sort of stable sticky deposit relationships is a level of precision to our depository partners. So, we want to be able to say, now it's May -- it's June, and our team is already out there talking with both existing and would be depository partners about where we think our needs may be as we get close to the end of the year. What durations make sense, et cetera, and also listening to what they have to say about what they think they can generate. And that's something that we really pride ourselves on being able to be flexible that way. And I think there are very few depositors that can really do that where you can actually have a discussion with the bank that says, listen, here's kind of what we have and they can say, well, listen, here's kind of what we think we can go out and generate as a matching asset and that's a very valuable discussion for both parties, it's an unusual one and one that the team really does try to leverage. So that's another sort of spin on this point that is an opportunity as you go out over time to basically get a little bit more, for lack of a better term, alpha, on deposits.

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Operator [89]

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And our next question comes from the line of Steven Wardell from Chardan Capital Markets.

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Steven William Wardell, Chardan Capital Markets, LLC, Research Division - Senior Equity Research Analyst [90]

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Can you -- you guys are now a few months into the selling season. Can you give us a sense of what you're hearing from the buyers marketplace and how this year's selling season is different from prior years and what kind of product preferences buyers are showing?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [91]

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Bill?

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William Robert Otten, HealthEquity, Inc. - EVP of Sales [92]

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Sure. Well, I can't speak to prior years before I got here. But the buyers are telling us that they want kind of a one-stop shop and they want to deal with a provider that's going to give them service. We hear that over and over again that a high level of service is the most important thing that they're looking to buy. Price is always part of the equation. But as Jon mentioned before, a happy client is the best salesperson we'll ever have and we're very fortunate to have many of those. So we are hearing several things, bundled services are important, upmarket, down-market all across the segments and that high-level of purple service I've mentioned before is also extremely important.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [93]

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I mean, I think the 2 words that really come to mind are accountability and education. So accountability is sort of what Bill is talking about. I don't think that -- I think customers are now sufficiently sophisticated that they want to know if the people that they are dealing with actually can make decisions. And if you are provider x and you're using outsourced platform y and/or there's trust attorney z who either works for another organization or works way apart from you and can't spell HSA and so on and there's a call center that handles this but also handles deposit calls or open enrollment calls, that's -- the days when that was acceptable, I think are rapidly coming to an end and I think, that's the accountability part of it. And the education part is things like what can you do to educate my team members year round so that, yes, during open enrollment, we're trying to get new people in, but during the year -- and Bill referenced an example of this with the university system -- what can we do year-round to help people really optimize the value of that HSA over the long term. And I actually do think, and, Bill, please feel free to comment [on this regard, or Steve]. I think that employers -- and I'm thinking about our key partner summit last week, 2 weeks ago, I mean, partners are really talking about this whole idea of the HSA being an absolutely critical part of how they can provide value to their employees in terms of building very flexible savings. Yes, for retirement but also for emergency needs, the kind of stuff that's more practical for your millennials and the like that maybe the idea of putting away $10,000 a year for 40 years from now isn't quite as appealing. So you can speak a little bit to the energy of that from our client.

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William Robert Otten, HealthEquity, Inc. - EVP of Sales [94]

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That's a good point, Jon. Steve, really what -- you've heard us say this a few times on the call, not just today but on prior calls, too. This concept of connecting health and wealth is exactly what Jon's talking about. Right here, as many of the employer groups are saying, they need some help linking these 2 things together because the 401(k) has been out there for a long time, people understand it. But it's only been only recently that everyone is starting to look at the HSA like a 401(k) for your retirement or an IRA for your retirement. So the employer groups are looking for our help. As Jon mentioned at key partner summit, we connected with many of our largest clients and they've asked us to come in and strategically plan with them to help them increase their adoption rate so that we can -- we had several clients there that have gone [full] replace and still they're looking for further education to be able to increase contribution levels from their existing employees. So I think you hit it on the head, Jon.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [95]

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What's so interesting about this, Steve, and I don't mean to go crazy on it, but -- is that I think what our employers are telling us that their members are looking for, and what we hear members looking for in dealing with members 24/7, 365 is it's less about what we would call financial advice, though we have plenty of members who reach out to us for our individualized investment advisor product. It's more like financial planning and budgeting. And if you're trying to budget for healthcare expenses, an HSA is an incredible tool. And just understanding how to use that and how to talk people through that, that's really, at some level, where they're looking for help. It's not all the highfalutin pie charts with this much in bonds and this much in stocks and so forth. It's like, to quote one of those radio debt guys, "it's like it's creating your snowball fund" at some level. That kind of thing that people are looking to do. And frankly, we're looking to improve and make more scalable the way we approach that. It's really actually pretty interesting and exciting to see some of the nuts and bolts of healthcare consumerism, around understanding your bills and all that kind of come together with the nuts and bolts of family budgeting for real people out there. And that's kind of where the markets are really talking about this year more so than ever in the past.

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Steven William Wardell, Chardan Capital Markets, LLC, Research Division - Senior Equity Research Analyst [96]

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And building on one of the prior questions on today's call. So if you were to go back a year ago and talk to organizations that held HSA assets and talk to them about potentially selling, a lot of them would've been reluctant because HSAs were so much in the spotlight a year ago. They would've held out for the highest price or tried to figure out how they could just hold onto them for longer. And that bucked the trend for the past 6 years of more consolidation in the sector. So where would you say we are now? Would you say that the sense of a year ago of [holding on to] assets who might have sold not selling? Has that faded and are we back to you [consolidation]?

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [97]

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I think on net, Steve, that there's a little bit of a thaw. There are 2 offsetting factors. As you say, I think the view at the beginning of the current administration that was some, "I'm not sure I understand this but I hear it in the news a lot," that kind of thing, that's definitely faded away. It's been replaced, to some extent, by the flip side of all of the demand for our deposits is that the deposits have become more valuable. And so there's a little bit of a reluctance there. But I think on net, the conversations are much more now about when rather than if. And so I think we'll be patient, but those transactions are going to be there.

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Operator [98]

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And I'm showing no further questions at this time. I would now like to turn the call back over the Jon Kessler for closing remarks.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [99]

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All right. I don't have any closing remarks except thank you all very much and we'll see everyone over the summer. And if not, we'll see everyone after Labor Day.

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Darcy G. Mott, HealthEquity, Inc. - Executive VP & CFO [100]

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Thank you.

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Jon Kessler, HealthEquity, Inc. - President, CEO & Director [101]

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Bye-bye.

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Operator [102]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.