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EXCEL - IDEA: XBRL DOCUMENT - HEALTHEQUITY, INC.Financial_Report.xls
EX-31.2 - 302 CFO CERTIFICATION - HEALTHEQUITY, INC.exhibit312.htm
EX-32.2 - 906 CFO CERTIFICATION - HEALTHEQUITY, INC.exhibit322.htm
EX-32.1 - 906 CEO CERTIFICATION - HEALTHEQUITY, INC.exhibit321.htm
EX-31.1 - 302 CEO CERTIFICATION - HEALTHEQUITY, INC.exhibit311.htm
EX-10.1 - EMPLOYMENT AGREEMENT - HEALTHEQUITY, INC.exhibit101-employmentagree.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to            
Commission File Number: 001-36568
 
 
 
HEALTHEQUITY, INC.
 
 
 

Delaware
 
7389
 
52-2383166
(State or other jurisdiction of
incorporation or organization)
 
(Primary Standard Industrial
Classification Code Number)
 
(I.R.S. Employer
Identification Number)
15 West Scenic Pointe Drive
Suite 100
Draper, Utah 84020
(877) 694-3942
(Address, including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Offices)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ¨ No þ

Indicate by check mark whether the registrant has submitted electronically and posted to its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
þ (Do not  check if a smaller reporting company)
Smaller reporting company
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

As of August 31, 2014, there were 54,726,740 shares of the registrant's common stock outstanding.

 





HealthEquity, Inc. and subsidiaries
Form 10-Q quarterly report

Table of contents
 
 
Page
Part I. FINANCIAL INFORMATION
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
Part II. OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
 
 



-2-


Part I. Financial information
Item 1. Financial statements

HealthEquity, Inc. and subsidiaries
Condensed consolidated balance sheets (unaudited)
(in thousands, except par value)
July 31, 2014


January 31, 2014

Assets



Current assets



Cash and cash equivalents
$
20,886


$
13,917

Accounts receivable, net of allowance for doubtful accounts of $40 as of July 31, 2014 and January 31, 2014
6,287


5,705

Inventories
369


391

Deferred tax asset
1,544


3,080

Prepaid expenses
2,029


663

Total current assets
31,115


23,756

Deferred offering costs
1,400



Property and equipment, net
2,549


1,992

Intangible assets, net
26,054


24,691

Goodwill
4,651


4,651

Total assets
$
65,769


$
55,090

Liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)



Current liabilities



Accounts payable
$
463


$
2,368

Accrued compensation
3,006


4,134

Accrued liabilities
2,755


2,927

Series D-3 dividends payable
344



Total current liabilities
6,568


9,429

Long-term liabilities



Deferred rent
435


393

Series D-3 redeemable convertible preferred stock derivative liability


6,182

Deferred tax liability
5,389


5,078

Total long-term liabilities
5,824


11,653

Total liabilities
12,392


21,082

Commitments and contingencies (see note 5)



Redeemable convertible preferred stock



Redeemable convertible preferred stock, $0.0001 par value, 26,473 shares authorized; 17,349 shares issued and outstanding as of July 31, 2014 and January 31, 2014; liquidation preference of $43,806 and $43,128 as of July 31, 2014 and January 31, 2014, respectively
42,693


46,714

Stockholders’ equity (deficit)



Convertible preferred stock, $0.0001 par value, 6,738 shares authorized, 6,156 shares issued and outstanding as of July 31, 2014 and January 31, 2014; liquidation preference of $13,011 and $12,764 as of July 31, 2014 and January 31, 2014, respectively
8,129


8,129

Common stock, $0.0001 par value, 70,000 shares authorized, 11,742 and 7,038 shares issued and outstanding as of July 31, 2014 and January 31, 2014, respectively
1


1

Common stock warrants
21


2,334

Additional paid-in capital
20,301



Accumulated deficit
(17,768
)

(23,170
)
Total stockholders’ equity (deficit)
10,684


(12,706
)
Total liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)
$
65,769


$
55,090

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

-3-


HealthEquity, Inc. and subsidiaries
Condensed consolidated statements of operations and
comprehensive income (unaudited)

Three months ended July 31,
 

Six months ended July 31,
 
(in thousands, except per share data)
2014


2013


2014


2013









Revenue







   Account fee revenue
$
10,548


$
7,209


$
20,936


$
14,225

   Custodial fee revenue
5,934


4,648


11,361


9,097

   Card fee revenue
4,233


3,014


8,531


6,076

   Other revenue
176


111


294


208

   Total revenue
20,891


14,982


41,122


29,606









 Cost of services







   Account costs
6,703


4,705


13,131


9,700

   Custodial costs
1,006


910


1,944


1,879

   Card costs
1,412


1,009


2,817


1,983

   Other costs
1


15


2


42

   Total cost of services
9,122


6,639


17,894


13,604









 Gross profit
11,769


8,343


23,228


16,002









 Operating expenses







   Sales and marketing
2,321


1,837


4,554


3,582

   Technology and development
2,302


1,659


4,488


3,328

   General and administrative
1,666


825


2,809


1,735

   Amortization of acquired intangible assets
409


409


818


818

   Total operating expenses
6,698


4,730


12,669


9,463









 Income from operations
5,071


3,613


10,559


6,539









 Other expense







   Interest expense


(10
)



(20
)
Loss on revaluation of redeemable convertible preferred stock derivative




(735
)


   Other expense, net
(39
)

(30
)

(131
)

(103
)








 Total other expense
(39
)

(40
)

(866
)

(123
)








 Income before income taxes
5,032


3,573


9,693


6,416









 Income tax provision
2,004


1,351


3,947


2,444









 Net income and comprehensive income
$
3,028


$
2,222


$
5,746


$
3,972









 Net income attributable to common stockholders:







 Basic
$
1,565


$
689


$
5,457


$
1,111

 Diluted
$
2,591


$
1,834


$
6,481


$
2,304









Net income per share attributable to common stockholders:







 Basic
$
0.19


$
0.12


$
0.70


$
0.20

 Diluted
$
0.06


$
0.05


$
0.14


$
0.08









Weighted-average number of shares used in computing net income per share attributable to common stockholders:







 







 Basic
8,135


5,566


7,757


5,529

 Diluted
41,680


37,504


45,847


28,268

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

-4-


HealthEquity, Inc. and subsidiaries
Condensed consolidated statements of redeemable convertible preferred stock and stockholders’ equity (deficit) (unaudited)
 
 
 
 
 
Stockholders’ equity (deficit)
 
 
Redeemable
convertible
preferred stock
 
 
Convertible
preferred stock
 
 
Common stock
 
 
Common
stock
warrants

 
Additional
paid-in
capital

 
Accumu-
lated
deficit

 
Total
stock-
holders'
equity
(deficit)

(in thousands, except exercise prices)
Shares

 
Amount

 
Shares

 
Amount

 
Shares

 
Amount

 
Balance as of January 31, 2014
17,349

 
$
46,714

 
6,156

 
$
8,129

 
7,038

 
$
1

 
$
2,334

 
$

 
$
(23,170
)
 
$
(12,706
)
Issuance of series D-3 redeemable convertible preferred stock cash dividend

 

 

 

 

 

 

 

 
(344
)
 
(344
)
Issuance of common stock:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of 2,938 warrants at $0.7976 per share

 

 

 

 
2,938

 

 
(2,313
)
 
4,656

 

 
2,343

Exercise of 1,766 options at $1.3494 per share

 

 

 

 
1,766

 

 

 
2,383

 

 
2,383

Stock-based compensation

 

 

 

 

 

 

 
468

 

 
468

Tax benefit on stock options exercised

 

 

 

 

 

 

 
1,856

 

 
1,856

Redeemable convertible preferred stock accretion

 
(4,021
)
 

 

 

 

 

 
4,021

 

 
4,021

Reclassification of series D-3 redeemable convertible preferred stock derivative liability

 

 

 

 

 

 

 
6,917

 

 
6,917

Net income

 

 

 

 

 

 

 

 
5,746

 
5,746

Balance as of July 31, 2014
17,349

 
$
42,693

 
6,156

 
$
8,129

 
11,742

 
$
1

 
$
21

 
$
20,301

 
$
(17,768
)
 
$
10,684

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.    

-5-


HealthEquity, Inc. and subsidiaries
Condensed consolidated statements of cash flows (unaudited)

Six months ended July 31,
 
(in thousands)
2014


2013





 Cash flows from operating activities:







 Net income
$
5,746


$
3,972





 Adjustments to reconcile net income to net cash provided by operating activities:







 Depreciation and amortization
2,643


1,989

 Revaluation of redeemable convertible preferred stock derivative
735



 Imputed interest on notes payable


20

 Deferred taxes
1,847


2,414

 Stock-based compensation
468


30

 Changes in operating assets and liabilities:





 Restricted cash


9

 Accounts receivable
(582
)

(290
)
 Inventories
22


(115
)
 Prepaid expenses
(1,366
)

(169
)
 Accounts payable
(1,905
)

(633
)
 Due to trust


(9
)
 Accrued compensation
(1,128
)

(915
)
 Accrued liabilities
(172
)

709

 Income taxes payable


(77
)
 Deferred rent
42


189





 Net cash provided by operating activities
6,350


7,124





 Cash flows from investing activities:







 Purchase of property and equipment
(1,047
)

(773
)
 Purchase of software and capitalized software development costs
(3,516
)

(1,627
)




 Net cash used in investing activities
(4,563
)

(2,400
)




 Cash flows from financing activities:







Repayment of notes payable


(1,500
)
Proceeds from exercise of common stock options
2,383


198

Proceeds from exercise of common stock warrants
2,343



Tax benefit from exercise of common stock options
1,856



Deferred offering costs
(1,400
)






 Net cash provided by (used in) financing activities
5,182


(1,302
)




 Increase in cash and cash equivalents
6,969


3,422





 Beginning cash and cash equivalents
13,917


5,905





 Ending cash and cash equivalents
$
20,886


$
9,327





Supplemental disclosures of non-cash investing and financing activities:



Common stock warrants exercised
2,313



Series D-3 redeemable convertible preferred stock dividend
344


344

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

-6-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 1. Summary of business and significant accounting policies
HealthEquity, Inc. was incorporated in the state of Delaware on September 18, 2002, and was organized to offer a full range of innovative solutions for managing health care accounts (Health Savings Accounts, Health Reimbursement Arrangements, and Flexible Spending Accounts) for health plans, insurance companies, and third-party administrators.
Principles of consolidation—The condensed consolidated financial statements include the accounts of HealthEquity, Inc. and its wholly owned subsidiaries, First HSA, LLC, First Horizon MSaver, Inc., HEQ Insurance Services, Inc., and HealthEquity Advisors, LLC (collectively referred to as the "Company"). All significant intercompany balances and transactions have been eliminated.
Basis of presentation—The accompanying condensed consolidated financial statements as of July 31, 2014 and for the six months ended July 31, 2014 and 2013 are unaudited and have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP") and the applicable rules and regulations of the Securities and Exchange Commission ("SEC") regarding interim financial reporting. In the opinion of management, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company's final prospectus (dated July 30, 2014) filed with the SEC pursuant to Rule 424(b) under the Securities Act of 1933 on August 1, 2014.
The fiscal year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.
Initial public offering—On August 5, 2014, the Company consummated its initial public offering ("IPO") and issued and sold 10,465,000 shares of its common stock at a public offering price of $14.00 per share, less the underwriters' discount. The Company received net proceeds of approximately $132.5 million after deducting underwriters' discounts and commissions of approximately $10.3 million and other offering expenses payable by the Company of approximately $3.7 million, of which approximately $1.4 million of the other offering expenses had been paid as of July 31, 2014. The underwriting discounts and commissions and other offering expenses were recorded as an offset against the IPO proceeds in additional paid-in capital upon the closing of the IPO on August 5, 2014. The net proceeds and other impacts of the IPO described herein are not reflected in the condensed consolidated financial statements as of July 31, 2014, as the Company consummated its IPO and received the proceeds subsequent to the end of the second fiscal quarter of 2015.
Recent accounting pronouncements—On May 28, 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for our annual and interim reporting periods beginning February 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on the consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor determined the effect of the standard on the ongoing financial reporting.
Note 2. Net income per share attributable to common stockholders
The Company computes net income per share of common stock in conformity with the two-class method required for participating securities. The Company considers its series D-3 redeemable convertible preferred stock to be participating securities as the holders of the preferred stock are entitled to receive a dividend in the event that a dividend is paid on common stock. The following table sets forth the computation of basic and diluted net income per share attributable to common stockholders:

-7-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 2. Net income per share attributable to common stockholders (continued)



Three months ended July 31,
 

Six months ended July 31,
 
(in thousands, except per share data)

2014


2013


2014


2013

Numerator (basic and diluted):








Net income

$
3,028


$
2,222


$
5,746


$
3,972

Less: accretion of redeemable convertible preferred stock



(340
)

4,021


(680
)
Less: dividend on redeemable convertible preferred stock and dividend on convertible preferred stock

(632
)

(650
)

(1,270
)

(1,301
)
Less: undistributed income attributed to redeemable convertible preferred stockholders

(831
)

(543
)

(3,040
)

(880
)
Net income attributable to common stockholders for basic earnings per share

$
1,565


$
689


$
5,457


$
1,111

Add back: dividend of redeemable convertible preferred stock

463


477


1,270


482

Add back: accretion on redeemable convertible preferred stock and dividend on convertible preferred stock



340


(4,021
)

209

Add back: series D-3 derivative liability revaluations





735



Add back: adjustment to undistributed income attributed to redeemable convertible preferred stockholders

563


328


3,040


502

Net income attributable to common stockholders for diluted earnings per share

$
2,591


$
1,834


$
6,481


$
2,304










Denominator (basic):








Weighted-average common shares outstanding

8,135


5,566


7,757


5,529

Denominator (diluted):








Weighted-average common shares outstanding

8,135


5,566


7,757


5,529

Effect of potential dilutive securities:








Weighted-average dilutive effect of stock options

3,050


770


3,207


920

Weighted-average dilutive effect of common shares from stock warrants

2,350


2,411


2,415


2,411

Dilutive effect from preferred stock assuming conversion

28,145


28,757


32,468


19,408

Weighted-average common shares outstanding

41,680


37,504


45,847


28,268

Net income per share attributable to common stockholders:








Basic

$
0.19


$
0.12


$
0.70


$
0.20

Diluted

$
0.06


$
0.05


$
0.14


$
0.08


For the three months ended July 31, 2014 and 2013, approximately 4.3 million and 5.8 million shares, respectively, attributable to outstanding series D-3 redeemable convertible preferred stock, common stock warrants and stock

-8-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 2. Net income per share attributable to common stockholders (continued)

options were excluded from the calculation of diluted earnings per share as their inclusion would have been anti-dilutive.
For the six months ended July 31, 2014 and 2013, approximately 2,000 and 15.0 million shares, respectively, attributable to outstanding series D-3 redeemable convertible preferred stock, series C redeemable convertible preferred stock, common stock warrants and stock options were excluded from the calculation of diluted earnings per share as their inclusion would have been anti-dilutive.
Note 3. Property and equipment
Property and equipment consisted of the following as of July 31, 2014 and January 31, 2014:
(in thousands)

July 31, 2014


January 31, 2014

Leasehold improvements

$
428


$
329

Furniture and fixtures

1,337


1,094

Computer equipment

3,780


3,075

Property and equipment, gross

5,545


4,498

Accumulated depreciation

(2,996
)

(2,506
)
Property and equipment, net

$
2,549


$
1,992

Depreciation expense for the three and six months ended July 31, 2014 and 2013 was $251,000, $186,000, $485,000 and $347,000, respectively.

Note 4. Intangible assets and goodwill
During the three and six months ended July 31, 2014 and 2013, the Company capitalized software development costs of $1.3 million, $301,000, $2.4 million and $605,000, respectively, related to significant enhancements and upgrades to its proprietary system.
The gross carrying amount and associated accumulated amortization of intangible assets is as follows as of July 31, 2014 and January 31, 2014:
(in thousands)

July 31, 2014


January 31, 2014

Amortized intangible assets:




Capitalized software development costs

$
7,689


$
5,290

Software

4,468


3,351

Acquired intangible member assets

24,563


24,563



36,720


33,204

Accumulated amortization

(10,666
)

(8,513
)
Intangible assets, net

$
26,054


$
24,691

During the three and six months ended July 31, 2014 and 2013, the Company incurred and expensed a total of $976,000, $580,000, $1.8 million and $1.1 million, respectively, in software development costs primarily related to the post-implementation and operation stages of its proprietary software.
Amortization expense for the three and six months ended July 31, 2014 and 2013 was $1.1 million, $823,000, $2.2 million and $1.6 million, respectively.


-9-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 4. Intangible assets and goodwill (continued)

All of the Company’s goodwill was generated from the acquisition of First Horizon MSaver, Inc. on August 11, 2011. There have been no changes to the goodwill carrying value during the three and six months ended July 31, 2014 and 2013.

Note 5. Commitments and contingencies
The Company’s principal commitments and contingencies consist of a processing services agreement with a vendor, and obligations for office space, data storage facilities, equipment and certain maintenance agreements under long-term, non-cancelable operating leases. These commitments as of January 31, 2014 are disclosed in the Company’s consolidated financial statements included in its final prospectus (dated July 30, 2014) filed with the SEC pursuant to Rule 424(b) under the Securities Act of 1933 on August 1, 2014, and did not change materially during the three and six months ended July 31, 2014 except for the following:
In March 2014, the Company modified its corporate office lease to expand its existing space for an additional commitment of $1.1 million over the term of the original lease.
Lease expense for office space for the three and six months ended July 31, 2014 and 2013 totaled $293,000, $222,000, $570,000 and $435,000, respectively. Expense for other agreements for the three and six months ended July 31, 2014 and 2013 totaled $47,000, $32,000, $99,000 and $65,000, respectively.

Note 6. Income taxes

The Company follows FASB Accounting Standards Codification 740-270, Income Taxes - Interim Reporting, for the computation and presentation of its interim period tax provision. Accordingly, management estimated the effective annual tax rate and applied this rate to the year-to-date pre-tax book income to determine the interim provision for income taxes. For the three and six months ended July 31, 2014, the Company recorded a provision for income taxes of $2.0 million and $3.9 million, respectively. The resulting effective tax rate was 39.8% and 40.7%, compared with an effective tax rate of 37.8% and 38.1% for the three and six months ended July 31, 2013, respectively. For the three and six months ended July 31, 2014, the net impact of discrete tax items caused a 1.3% and 0.5% decrease to the effective tax rate primarily due to the tax benefit on book stock compensation expense on stock options vesting upon the Company’s initial public offering, partially offset by changes in tax rates on the Company’s deferred tax assets and liabilities. For the three and six months ended July 31, 2013, the net impact of discrete tax items was not material. The effective tax rate increased over the same period last year primarily due to an increase in permanent tax items in relation to income before income taxes, expiration of the federal research and development tax credits as of December 31, 2013, and discrete tax items.
As of July 31, 2014 and January 31, 2014, the Company’s total gross unrecognized tax benefit was $264,000 and $256,000, respectively. As a result of Accounting Standards Update No. 2013-11, certain unrecognized tax benefits have been netted against their related deferred tax assets. As a result, the unrecognized tax benefit recorded as of July 31, 2014 and January 31, 2014 remains unchanged in the amount of $47,000. Substantially all of the gross unrecognized tax benefit, if recognized, would affect the Company’s effective tax rate. The Company anticipates a decrease of $22,000 in total gross unrecognized tax benefits within 12 months of the reporting date related to an uncertain tax position on research and development credits claimed for which a lapse of the applicable statute of limitations is expected.
The Company files income tax returns with U.S. federal and state taxing jurisdictions and is not currently under examination with any jurisdiction. The Company remains subject to examination by federal and various state taxing jurisdictions for tax years after 2002.

-10-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 7. Redeemable convertible preferred stock and convertible preferred stock
Redeemable convertible preferred stock and convertible preferred stock consisted of the following:
As of July 31, 2014 (in thousands)
  
 
Shares
 
 
  
 
  
 
 
 
 
Issued and

 
Liquidation

 
Carrying

Series
 
Authorized

 
outstanding

 
preference

 
value

Redeemable convertible preferred stock:
 
 
 
 
 
 
 
 
Series C
 
6,773

 
6,751

 
$
23,002

 
$
22,232

Series D-1
 
9,000

 
5,835

 
8,656

 
8,340

Series D-2
 
3,200

 
440

 
736

 
709

Series D-3
 
7,500

 
4,323

 
11,412

 
11,412

Total redeemable convertible preferred stock
 
26,473

 
17,349

 
$
43,806

 
$
42,693

Convertible preferred stock:
 
 
 
 
 
 
 
 
Series A
 
2,000

 
2,000

 
$
3,351

 
$
2,000

Series B
 
4,738

 
4,156

 
9,660

 
6,129

Total convertible preferred stock
 
6,738

 
6,156

 
$
13,011

 
$
8,129

As of January 31, 2014 (in thousands)
  
 
Shares
 
 
  
 
  
Series
 
Authorized

 
Issued and
outstanding

 
Liquidation
preference

 
Carrying
value

Redeemable convertible preferred stock:
 
 
 
 
 
 
 
 
Series C
 
6,773

 
6,751

 
$
22,533

 
$
22,232

Series D-1
 
9,000

 
5,835

 
8,464

 
8,340

Series D-2
 
3,200

 
440

 
719

 
709

Series D-3
 
7,500

 
4,323

 
11,412

 
15,433

Total redeemable convertible preferred stock
 
26,473

 
17,349

 
$
43,128

 
$
46,714

Convertible preferred stock:
 
 
 
 
 
 
 
 
Series A
 
2,000

 
2,000

 
$
3,291

 
$
2,000

Series B
 
4,738

 
4,156

 
9,473

 
6,129

Total convertible preferred stock
 
6,738

 
6,156

 
$
12,764

 
$
8,129

As of July 31, 2014, the Company had outstanding series A and B convertible preferred stock and series C, D-1, D-2, and D-3 redeemable convertible preferred stock.
In accordance with the redeemable and convertible preferred stock terms, series A, B, and D-3 convert into shares of common stock on a 1:1 basis, series C on a 1:1.38 basis, and series D-1 on a 1:2 basis, and series D-2 on a 1:2.27 basis. In connection with the Company's IPO, all outstanding redeemable and convertible preferred stock converted to 32,486,588 shares of common stock. As a result, as of August 4, 2014, amounts associated with the redeemable and convertible preferred stock have been reclassified to additional paid-in capital.

Note 8. Common stock warrants
In conjunction with a rights equalization agreement, the Company issued warrants to series A convertible preferred stockholders to purchase 150,000 shares of its common stock for $1.00 per share, The warrants were exercisable through November 2015, of which 26,000 were exercised with 124,000 outstanding as of January 31, 2014. The

-11-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 8. Common stock warrants (continued)

124,000 warrants outstanding as January 31, 2014 were all exercised during the six months ended July 31, 2014. The warrants had a fair market value of $51,000 at the date of issuance.
In conjunction with the series B convertible preferred stock, warrants to purchase 400,000 shares of common stock with an exercise price of $1.00 per share were granted to series B convertible preferred stockholders. The warrants were exercisable through February 2014, of which 400,000 and 50,000 were exercised as of July 31, 2014 and January 31, 2014, respectively. The 350,000 warrants outstanding as of January 31, 2014 were all exercised during the six months ended July 31, 2014. The warrants had a fair market value of $44,000 at the date of issuance.
The Company issued warrants to purchase an additional 200,000 shares of common stock to series B convertible preferred stockholders with an exercise price of $1.00 per share. The warrants are exercisable through September 2015, of which 188,000 and 5,000 were exercised with 12,000 and 195,000 outstanding as of July 31, 2014 and January 31, 2014, respectively. The warrants had a fair market value of $66,000 at the date of issuance.
In conjunction with the series C redeemable convertible preferred stock, the Company issued detachable warrants to purchase 600,000 shares of common stock with an exercise price of $1.50 per share to series C redeemable convertible preferred stockholders. The warrants are exercisable through August 2016, of which 585,000 and 10,000 were exercised as of July 31, 2014 and January 31, 2014 with 15,000 and 590,000 outstanding as of July 31, 2014 and January 31, 2014, respectively. The warrants had a fair market value of $339,000 at the date of issuance. The Company issued warrants to purchase an additional 1.0 million shares of common stock to series C redeemable convertible preferred stockholders with an exercise price of $0.01 per share. The warrants are exercisable through May 7, 2017, of which 1.0 million and 4,000 were exercised as of July 31, 2014 and January 31, 2014 with 5,000 and 1.0 million outstanding as of July 31, 2014 and January 31, 2014. The warrants had a fair market value of $1.6 million at the date of issuance.
In conjunction with the series D-1 redeemable convertible preferred stock, the Company issued detachable warrants to purchase 400,000 shares of common stock with an exercise price of $2.00 per share. The warrants are exercisable upon the option of the stockholder through August 2018, of which 397,000 were exercised as of July 31, 2014, with 3,000 and 400,000 outstanding as of July 31, 2014 and January 31, 2014, respectively.
In conjunction with the series D-3 redeemable convertible preferred stock, warrants to purchase 966,000 shares of common stock with an exercise price of $0.01 per share were granted to series D-3 redeemable convertible preferred stockholders. The warrants are exercisable through August 2021, of which 767,000 were exercised with 199,000 outstanding as of January 31, 2014. The warrants outstanding as of January 31, 2014 were all exercised during the six months ended July 31, 2014. The warrants had a value of $1.7 million at the date of issuance.
As a result of the foregoing, as of July 31, 2014, there were 35,000 warrants outstanding in total.

Note 9. Stock options
On January 30, 2014, the Company’s board of directors approved and the Company adopted a 2014 Equity Incentive Plan (the "Incentive Plan") providing for the issuance of stock options to the directors and employees of the Company to purchase up to an aggregate of 600,000 shares of common stock. No stock options were issued to directors of the Company from the Incentive Plan as of January 31, 2014.
In July 2014, the Company's board of directors voted to increase the shares of common stock reserved under the Incentive Plan by 2,000,000 shares from 600,000 shares of common stock to 2,600,000 shares of common stock. In addition, the board of directors voted to provide that the number of shares of common stock reserved for issuance under the Incentive Plan will automatically increase on February 1 of each year, beginning as of February 1, 2015 and continuing through and including February 1, 2024, by 3% of the total number of shares of the Company’s capital stock outstanding on January 31 of the preceding fiscal year, or a lesser number of shares determined by the board of directors. As of July 31, 2014, 623,000 shares were available for grant under the Incentive Plan.

-12-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 9. Stock Options (continued)

Under the terms of the Incentive Plan, the Company has the ability to grant incentive and nonstatutory stock options. Incentive stock options may be granted only to Company employees. Nonstatutory stock options may be granted to Company employees, directors and consultants. Such options are to be exercisable at prices, as determined by the board of directors, which must be equal to no less than the fair value of the Company's common stock at the date of the grant. Stock options granted under the Incentive Plan generally expire 10 years from the date of issuance, or are forfeited 90 days after termination of employment. Any stock options that are forfeited or that expire are returned to the Incentive Plan.
Upon the pricing of the IPO, the Company granted 431,500 time-based stock options to certain directors and key employees, 349,000 of which vest over a period of 4 years and 82,500 of which vest on January 31, 2015. In addition, upon the pricing of the IPO, the Company granted 1.4 million performance-based stock options to certain key employees under the Incentive Plan, which vest upon the achievement of certain performance criteria. The performance based stock options vest upon the attainment of the following performance criteria: (a) 10% of the stock options vest upon attainment of at least $34.5 million in Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") for the fiscal year 2016, (b) 20% of the stock options vest upon the attainment of an annual growth rate of Adjusted EBITDA per share of common stock of 30% for the fiscal year 2017, (c) 30% of the stock options vest upon the attainment of an annual growth rate of Adjusted EBITDA per share of common stock of 30% for fiscal year 2018, and (d) 40% of the stock options vest upon the attainment of an annual growth rate of Adjusted EBITDA per share of common stock of 25% for fiscal year 2019.
A summary of stock option activity is as follows:
  

Outstanding stock options
 
(in thousands, except for exercise prices and term)

Number of
options


Range of
exercise
prices

Weighted-
average
exercise
price


Weighted-
average
contractual
term
(in years)

Aggregate
intrinsic
value

Outstanding as of January 31, 2014

6,369


$1.10 - 4.50

$
1.77


6.34

$
14,621

Granted

1,832


$14.00 - 14.00

$
14.00





Exercised

(1,766
)

$1.10 - 2.50

$
1.35





Forfeited

(24
)

$2.25 - 4.50

$
2.49





Outstanding as of July 31, 2014

6,411


$1.10 - 14.00

$
5.38


7.26

$
78,336


-13-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 9. Stock Options (continued)

A summary regarding non-vested and exercisable stock options is as follows:
  

Non-vested stock options
 

Exercisable stock options
 
(in thousands, except for exercise prices and term)

Number of
shares


Weighted
average
grant date
fair value


Number of
shares


Weighted
average
exercise
price


Weighted
average
contractual
term
(in years)

Aggregate
intrinsic
value

Balance as of January 31, 2014

2,812


$
0.26


3,557


$
1.30


5.03

$
9,835

Granted

1,832


$
5.15









Vesting

(2,140
)

$
0.22


2,140


$
2.24





Exercised





(1,766
)

$
1.35





Forfeited/expired

(21
)

$
0.25


(3
)

$
2.25





Balance as of July 31, 2014

2,483


$
3.90


3,928


$
1.79


5.75

$
62,123

Vested and expected to vest as of July 31, 2014





4,741


$
2.73


6.34

$
70,503

The aggregate intrinsic value in the tables above represents the difference between the estimated fair value of common stock and the exercise price of outstanding, in-the-money stock options.
The total intrinsic value of stock options exercised in the three and six months ended July 31, 2014 and 2013 was $17.0 million, $22,000, $18.7 million and $135,000, respectively.
The key input assumptions that were utilized in the valuation of the stock options granted during the three and six months ended July 31, 2014 and 2013 are as follows:
  

Three months ended July 31,
 

Six months ended July 31,
 
  

2014


2013


2014


2013

Expected dividend yield

%

%

%

%
Expected stock price volatility

32.9
%

31.3
%

32.9
%

31.3
%
Risk-free interest rate

2.24
%

0.35
%

2.24
%

0.35
%
Expected life of options

6.25 years


3 years


6.25 years


3 years

As of July 31, 2014, the weighted-average vesting period of non-vested awards expected to vest approximates 3.6 years; the amount of compensation expense the Company expects to recognize for stock options vesting in future periods approximates $1.6 million.
During the three and six months ended July 31, 2014, the Company recorded compensation expense of $387,000 and $436,000, respectively, related to the performance-based options based on the Company's probability assessment of attaining its Adjusted EBITDA target and consummation of the IPO.

Note 10. Fair value
A derivative liability was recorded related to the Company’s series D-3 redeemable convertible preferred stock due to stated features allowing for redemption equal to the greater of the fair value per share of series D-3 redeemable convertible preferred stock, or the liquidation preference per share of series D-3 redeemable convertible preferred stock. The derivative instrument is recorded at its fair value, using an option pricing model, and is adjusted to fair value as of the end of each reporting period. Changes in the fair value of derivative instruments are recognized

-14-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 10. Fair value (continued)

currently in the condensed consolidated financial statements. The Company has classified this derivative financial instrument as Level 3 in the fair value hierarchy. The Company continued to record adjustments to the fair value of the derivative liability until March 31, 2014, at which time the Company modified the terms of the series D-3 redeemable convertible preferred stock. As a result of the modifications, the Company reclassified the aggregate fair value of the liability to additional paid-in capital.
The following table includes a roll forward of the amounts for the three and six months ended July 31, 2014 and     2013 for instruments classified within Level 3. The classification within Level 3 is based upon significance of the unobservable inputs to the overall fair value measurement.


Three months ended July 31,
 

Six months ended July 31,
 
(in thousands)

2014


2013


2014


2013

Balance at beginning of period

$


$
818


$
6,182


$
818

Loss on revaluation





735



Warrants exercised








Elimination of liability due to removal of FMV provision





(6,917
)


Balance at end of period

$


$
818


$


$
818

The following table summarizes the significant quantitative inputs and assumptions used for items categorized in Level 3 of the fair value hierarchy as of January 31, 2014:
Series D-3 redeemable convertible preferred stock derivative liability


January 31, 2014

Market value of common stock on measurement date

$
4.06

Projected exercise price

$
2.64

Risk-free interest rate

0.06
%
Expected lives

180 days

Expected volatility

25.2
%
Probability of liquidation event

%

There are no other financial instruments that are considered Level 1 or Level 2 as of July 31, 2014 and January 31, 2014.

Note 11. Related party transactions
The Company had entered into a consulting agreement with a company owned by the President and Chief Executive Officer of the Company. For the three and six months ended July 31, 2014 and 2013, amounts paid to this company under the terms of the consulting agreement totaled $81,000, $181,000, $162,000 and $288,000, respectively. In connection with the consummation of the Company's IPO, this consulting agreement was terminated.

Note 12. Subsequent events
On July 14, 2014, the Company's board of directors approved an amended and restated certificate of incorporation, according to which the total number of shares of all classes of capital stock that the Company is authorized to issue is 1,000,000,000 shares, including 900,000,000 shares of common stock and 100,000,000 shares of preferred

-15-


HealthEquity, Inc. and subsidiaries
Notes to condensed consolidated financial statements (unaudited)

Note 12. Subsequent events (continued)

stock, par value $0.0001 per share. The amended and restated certificate of incorporation was filed with the Secretary of State of the State of Delaware and became effective on August 5, 2014.
On July 14, 2014, the Company's board of directors declared a cash dividend in an aggregate amount of $50 million on shares of the Company's common stock outstanding on August 4, 2014 (after giving effect to the conversion of all outstanding convertible preferred stock and redeemable convertible preferred stock into shares of common stock). The terms of each of the Company's stock plans, including, the 2003 Director Stock Plan, 2003 Stock Plan, 2005 Stock Plan, 2006 Stock Plan, 2009 Stock Plan and the Incentive Plan requires an adjustment to outstanding stock options to prevent dilution of the holders’ interests as a result of the foregoing special dividend. Accordingly, the Company's board of directors approved an adjustment to reduce the exercise price of each of the stock options outstanding as of the record date, August 4, 2014, for the dividend by $1.00.
As of the close of business on August 4, 2014, all of the Company's redeemable convertible preferred stock and convertible preferred stock was converted into 32,486,588 shares of common stock.
On August 5, 2014, the Company consummated its IPO and issued and sold 10,465,000 shares of common stock at a public offering price of $14.00 per share, less the underwriters' discount. The shares began trading on the NASDAQ Global Select Market on July 31, 2014. The Company received net proceeds of approximately $132.5 million after deducting underwriting discounts and commissions of approximately $10.3 million and other offering expenses payable by the Company of approximately $3.7 million, of which approximately $1.4 million of the other offering expenses had been paid as of July 31, 2014. The underwriting discounts and commissions and other offering expenses were recorded as an offset against the IPO proceeds in additional paid-in capital upon the closing of the IPO on August 5, 2014.
The net proceeds and other impacts of the IPO described above are not reflected in the condensed consolidated financial statements as of July 31, 2014, as the Company consummated its IPO and received the proceeds subsequent to the end of the second fiscal quarter of 2015.


-16-


Item 2. Management’s discussion and analysis of financial condition and results of operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would” and similar expressions or variations intended to identify forward-looking statements. Such statements include, but are not limited to, statements concerning market opportunity, our future financial and operating results, investment strategy, sales and marketing strategy, management’s plans, beliefs and objectives for future operations, technology and development, economic and industry trends or trend analysis, expectations about seasonality, opportunity for portfolio purchases, use of non-GAAP financial measures, operating expenses, anticipated income tax rates, capital expenditures, cash flows and liquidity. These statements are based on the beliefs and assumptions of our management based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included under Part II, Item 1A below. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such events.

Overview
We are a leader and an innovator in the high-growth category of technology-enabled services platforms that empower consumers to make healthcare saving and spending decisions. Our platform provides an ecosystem where consumers can access their tax-advantaged healthcare savings, compare treatment options and pricing, evaluate and pay healthcare bills, receive personalized benefit and clinical information, earn wellness incentives, and make educated investment choices to grow their tax-advantaged healthcare savings.
The core of our ecosystem is the health savings account, or HSA, a financial account through which consumers spend and save long-term for healthcare on a tax-advantaged basis. We are the integrated HSA platform for 20 of the 50 largest health plans in the country, a number of which are among 28 Blue Cross and Blue Shield health plans in 26 states, and more than 25,000 employer clients, including industry leaders such as American Express Company, Dow Corning Corporation, eBay, Inc., Google, Inc., Intermountain Healthcare and Kohl’s Corporation. Through our Network Partners, we have the potential to reach over 55 million consumers, representing approximately 30% of the under-age 65 privately insured population in the United States.
Since our inception in 2002, we have been committed to developing technology solutions that empower healthcare consumers. In 2003, we began offering live 24/7/365 consumer support from health saving and spending experts. In 2005, we integrated HSAs with our first Health Plan Partner, and in 2006, we were authorized to act as an HSA custodian by the U.S. Department of the Treasury. In 2009, we integrated HSAs with multiple health plans of a single large employer, began delivering integrated wellness incentives through an HSA, and partnered with a private health insurance exchange as its preferred HSA partner. In 2011, we integrated HSAs, reimbursement arrangements, or RAs, and investment accounts on one website, and in 2013, we began delivering HSA-specific investment advice online.
Our customers include individuals, employers of all sizes and health plans. We refer to our individual customers as our members, all of our health plan customers as our Health Plan Partners and our employer customers with more than 1,000 employees as our Employer Partners. Our Health Plan Partners and Employer Partners collectively constitute our Network Partners.
We generate revenue primarily from three sources: account fees, custodial fees and card fees. We generate account fee revenue by providing monthly account services on our platform, primarily through multi-year contracts

-17-


with our Network Partners that are typically three to five years in duration. We generate custodial fee revenue from interest we earn on cash assets under management, or AUM, deposited with our FDIC-insured custodial depository bank partners, and recordkeeping fees we earn from mutual funds in which our members invest on a self-directed basis. We also generate payment card fee revenue from interchange fees that we earn on payments that our members make using our physical and virtual payment cards.

Key factors affecting our performance
We believe that our performance and future success are driven by a number of factors, including those identified below. Each of these factors presents both significant opportunities and significant risks to our future performance. See the section entitled “Risk factors.”
Structural change in U.S. private health insurance
Substantially all of our revenue is derived from healthcare-related saving and spending by consumers, which is impacted by changes affecting the broader healthcare industry. The healthcare industry has changed significantly in recent years, and we expect that significant changes will continue to occur that will result in increased participation in high deductible health plans that are eligible to be coupled with HSAs, or HSA Plans, and other consumer-centric health plans. In particular, we believe that the implementation of the Patient Protection and Affordable Care Act of 2010, or PPACA, over the remainder of this decade, continued growth in healthcare costs, and related factors will spur HSA Plan and HSA growth; however, the timing and impact of these and other developments in the healthcare industry are difficult to predict.
Attracting and penetrating network partners
We created our business model to take advantage of the changing dynamics of the U.S. private health insurance market. Our model is based on a business-to-business-to-consumer, or B2B2C, distribution strategy, meaning we rely on our Employer Partners and Health Plan Partners to reach potential members to increase the number of HSAs for which we serve as custodian, which we refer to of HSAs for which we serve as custodian, which we refer to as our HSA Members. Our success depends in large part on our ability to further penetrate our existing Network Partners by adding new members from these partners and adding new Network Partners.
Our innovative technology platform
We believe that innovations incorporated in our technology that enable consumers to make healthcare saving and spending decisions differentiate us from our competitors and drive our growth in revenue, HSA Members, Network Partners and AUM. Similarly, these innovations underpin our ability to provide a differentiated consumer experience in a cost-effective manner. For example, we are currently undertaking a significant update of our proprietary platform’s architecture, which will allow us to decrease our maintenance spending and increase our budget for innovation initiatives. As part of this project, we are also investing in improvements in our transaction processing capabilities and related platform infrastructure to support continued account and transaction growth. We intend to continue to invest aggressively in our technology development to enhance our platform’s capabilities and infrastructure.
Our “Purple” culture
The new healthcare consumer needs education and advice delivered by people as well as technology. We believe that our team-oriented customer-focused culture, which we call “Purple,” is a significant factor in our ability to attract and retain customers and to nimbly address opportunities in the rapidly changing healthcare sector. We make significant efforts to promote and foster Purple within our workforce. We invest in and intend to continue to invest in human capital through technology-enabled training, career development and advancement opportunities. We regularly measure the success of these efforts, particularly in the context of rapid growth.
Interest rates
As a non-bank custodian, we contract with FDIC-insured custodial depository bank partners to hold cash AUM, and we generate a significant portion of our total revenue from fees we charge based on interest rates offered to us by these partners. These contracts are long-term, substantially reducing our exposure to short-term fluctuations in interest rates. A sustained decline in prevailing interest rates may negatively affect our business by reducing the size of the interest rate margins available to us and thus the size of the custodial fees we can charge our members. Conversely, a sustained increase in prevailing interest rates would present us with an opportunity to increase our interest rate margins. Changes in prevailing interest rates are driven by macroeconomic trends and government policies over which we have no control.

-18-


Our competition and industry
Our direct competitors are HSA custodians, of which there are over 2,200 currently competing in the market. These are primarily state or federally chartered banks and other financial institutions for which we believe technology-based healthcare services are not a core business. Certain of our direct competitors have chosen to exit the market despite increased demand for these services. This has created, and we believe will continue to create, opportunities for us to leverage our technology platform and capabilities to increase our market share. However, some of our direct competitors are in a position, should they choose, to devote more resources to the development, sale and support of their products and services than we have at our disposal. In addition, numerous indirect competitors, including benefits administration technology and service providers, partner with banks and other HSA custodians to compete with us. Our Health Plan Partners may also choose to offer technology-based healthcare services directly, as some health plans have done. Our success depends on our ability to predict and react quickly to these and other industry and competitive dynamics.
Regulatory change
Federal law and regulations, including the PPACA, IRS regulations, labor law and public health regulations that govern the provision of health insurance and are the foundation for tax-advantaged healthcare saving and spending through HSAs and RAs, play a pivotal role in determining our market opportunity. Privacy and data security-related laws such as Health Insurance Portability and Accountability Act of 1996, or HIPAA, and the Gramm-Leach-Bliley Act, laws governing the provision of investment advice to consumers, such as the Investment Advisers Act of 1940, and the Federal Deposit Insurance Act, all play a similar role in determining our competitive landscape. In addition, state-level regulations also have significant implications for our business in some cases. Our ability to predict and react quickly to relevant legal and regulatory trends and to correctly interpret their market and competitive implications is important to our success.

Key financial and operating metrics
Our management regularly reviews a number of key operating and financial metrics to evaluate our business, determine the allocation of our resources, make decisions regarding corporate strategies and evaluate forward-looking projections and trends affecting our business. We discuss certain of these key financial metrics, including revenue, below in the section entitled “—Key components of our results of operations.” In addition, we utilize other key metrics as described below.
HSA members
The following table sets forth our HSA Members as of the periods indicated:


July 31, 2014


July 31, 2013


% Change


January 31, 2014

 HSA Members

1,061,713


728,346


46
%

967,710

 Average HSA Members

1,015,539


701,072


45
%

747,182

We define an HSA Member as an HSA for which we serve as custodian. Tracking the number of our HSA Members is critical because our account fee revenue is driven by the administrative fees we charge per account.
The number of our HSA Members increased by approximately 333,000, or 46%, from July 31, 2013 to July 31, 2014, and by approximately 94,000, or 10%, from 967,710 as of January 31, 2014 to 1,061,713 as of July 31, 2014.
The increase in the number of our HSA Members in these periods was driven by the addition of new Network Partners and further penetration into existing Network Partners.
Assets under management
The following table sets forth our AUM as of the periods indicated:
(in thousands, except percentages)

July 31, 2014


July 31, 2013


$ Change


% Change


January 31, 2014

Cash AUM

$
1,546,753


$
1,129,490


$
417,263


37
%

$
1,442,336

Investment AUM

237,831


134,417


103,414


77
%

182,614

Total AUM

$
1,784,584


$
1,263,907


$
520,677


41
%

$
1,624,950

Average daily cash AUM

$
1,480,075


$
1,096,021


$
384,054


35
%

$
1,137,825


-19-


We define AUM as our custodial assets under management. Our AUM consists of two components: (1) cash AUM, or our members’ HSA assets that are deposited with our FDIC-insured custodial depository bank partners; and (2) investment AUM, or our members’ HSA assets that are invested in mutual funds through our custodial investment fund partner. Measuring our AUM is important because our custodial fee revenue is determined by the applicable account yields and average daily AUM balances.
Our AUM increased by $520.7 million, or 41%, from $1.26 billion as of July 31, 2013 to $1.78 billion as of July 31, 2014. Our AUM increased by $159.6 million, or 10%, from $1.62 billion as of January 31, 2014 to $1.78 billion as of July 31, 2014. The increase in AUM in these periods was driven by additional AUM from our existing HSA Members and new AUM from new HSA Members added during the fiscal year.
Adjusted EBITDA
The following table sets forth our Adjusted EBITDA:

Three months ended July 31,
 





Six months ended July 31,
 




(in thousands, except percentages)
2014


2013


$ Change


% Change


2014


2013


$ Change


% Change

Adjusted EBITDA
$
6,866


$
4,637


$
2,229


48
%

$
13,671


$
8,476


$
5,195


61
%
We define Adjusted EBITDA, which is a non-GAAP financial metric, as adjusted earnings before interest, taxes, depreciation and amortization and certain other non-cash statement of operations items. We believe that Adjusted EBITDA provides useful information to investors and analysts in understanding and evaluating our operating results in the same manner as our management and our board of directors because it reflects operating profitability before consideration of non-operating expenses and non-cash expenses, and serves as a basis for comparison against other companies in our industry.
Our Adjusted EBITDA increased by $2.2 million, or 48%, from $4.6 million for the three months ended July 31, 2013 to $6.9 million for the three months ended July 31, 2014. The increase in Adjusted EBITDA was driven by the overall growth of our business, including a $1.5 million, or 40%, increase in income from operations.
Our Adjusted EBITDA increased by $5.2 million, or 61%, from $8.5 million for the six months ended July 31, 2013 to $13.7 million for the six months ended July 31, 2014. The increase in Adjusted EBITDA was driven by the overall growth of our business, including a $4.0 million, or 61%, increase in income from operations.
Our use of Adjusted EBITDA has limitations as an analytical tool, and it should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP.
The following table presents a reconciliation of net income and comprehensive income, the most comparable GAAP financial measure, to Adjusted EBITDA for each of the periods indicated:


Three months ended July 31,
 

Six months ended July 31,
 
(in thousands)

2014


2013


2014


2013

Net income and comprehensive income

$
3,028


$
2,222


$
5,746


$
3,972

Interest expense



10




20

Income tax provision

2,004


1,351


3,947


2,444

Depreciation and amortization

983


600


1,825


1,171

Amortization of acquired intangible assets

409


409


818


818

Loss on revaluation of redeemable convertible preferred stock derivative liability





735



Other (1)

442


45


600


51

Total adjustments

$
3,838


$
2,415


$
7,925


$
4,504

Adjusted EBITDA

$
6,866


$
4,637


$
13,671


$
8,476

(1)
For the three and six months ended July 31, 2014 and 2013, Other consisted of interest income of $0, $(12), $0 and $(24), miscellaneous taxes of $39, $42, $132 and $44, and stock-based compensation expense of $403, $15, $468 and $31, respectively.

-20-


Key components of our results of operations
Revenue
The following table sets forth our revenue for the periods indicated:

Three months ended July 31,
 





Six months ended July 31,
 




(in thousands, except percentages)
2014


2013


$ Change


% Change


2014


2013


$ Change


% Change

Account fee revenue
$
10,548


$
7,209


$
3,339


46
%

$
20,936


$
14,225


$
6,711


47
%
Custodial fee revenue
5,934


4,648


1,286


28
%

11,361


9,097


2,264


25
%
Card fee revenue
4,233


3,014


1,219


40
%

8,531


6,076


2,455


40
%
Other revenue
176


111


65


59
%

294


208


86


41
%
Total revenue
$
20,891


$
14,982


$
5,909


39
%

$
41,122


$
29,606


$
11,516


39
%
We generate revenue from three primary sources: account fees, custodial fees and card fees. We also generate other revenue, primarily from marketing materials that we produce for our Network Partners.
Account fee revenue.    We earn account fee revenue from the fees we charge our Network Partners, employer clients and individual members for the administration services we provide in connection with the Health Savings Accounts ("HSA") and Health Reimbursement Arrangements ("HRA") we offer. Our fees are generally fixed for the duration of our agreement with the relevant customer, which is typically three to five years, and are paid to us on a monthly basis. We recognize revenue on a monthly basis as services are rendered under our written service agreements.
Custodial fee revenue.    We earn custodial revenue from our AUM held in trust with our FDIC-insured custodial depository bank partners and our custodial investment partners. As a non-bank custodian, we deposit our cash AUM with our various bank partners pursuant to contracts that (i) have terms up to five years, (ii) provide for a fixed or variable interest rate payable on the average daily cash balances deposited with the relevant bank partner, and (iii) have minimum and maximum required deposit balances. We earn custodial fees on our cash AUM that are based on the interest rates offered to us by these bank partners. In addition, once a member’s HSA cash balance reaches a certain threshold, the member is able to invest his or her HSA assets in mutual funds through our custodial investment partner. We receive a recordkeeping fee related to such investment AUM.
Card fee revenue.    We earn card fee revenue each time one of our members uses one of our payment cards to make a qualified purchase. These card fees are collected each time a member “swipes” our payment card to pay a healthcare-related expense. We recognize card fee revenue monthly based on reports received from third parties, namely, the card-issuing bank and the card processor.
Cost of services
Cost of services includes costs related to servicing member accounts, managing customer and partner relationships and processing reimbursement claims. Expenditures include personnel-related costs, depreciation, amortization, stock-based compensation, common expense allocations, and other operating costs related to servicing our members. Other components of cost of services include interest paid to members on cash AUM and card costs incurred in connection with processing card transactions for our members.

Account costs.    Account costs include the account servicing costs described above. Additionally, for new accounts, we incur on-boarding costs associated with the new accounts, such as new member welcome kits and the cost associated with issuance of new payment cards.
Custodial costs.    Custodial costs are comprised of interest we pay to our HSA Members and fees we pay to banking consultants whom we use to help secure agreements with our FDIC-insured custodial depository banking partners. We pay interest to HSA Members on a tiered basis. The interest rates we pay to HSA Members can be changed at any time upon required notice, typically 30 days.
Card costs.    Card costs are comprised of costs we incur in connection with processing payment card transactions initiated by our members. Due to the substantiation requirement on RA-linked payment card transactions, which is the requirement that we confirm each purchase involves a qualified medical expense as defined under applicable law, payment card costs are higher for RA card transactions. In addition to fixed per card fees, we are assessed additional transaction costs determined by the amount of the card transaction.
Other costs.    Other costs are comprised of costs of marketing materials that we produce for our Network Partners.

-21-


Gross profit and gross margin
Our gross profit is our total revenue minus our total cost of services, and our gross margin is our gross profit expressed as a percentage of our total revenue. Our gross margin has been and will continue to be affected by a number of factors, including the fees we charge per account, interest rates, how many services we deliver per account, and card processing costs per account. We expect our annual gross margin to remain relatively steady over the near term, although our gross margin could fluctuate from period to period depending on the interplay of these factors.
Operating expenses
Sales and marketing.    Sales and marketing expenses consist primarily of personnel and related expenses for our sales and marketing staff, including sales commissions for our direct sales force, external agent/broker commission expenses, marketing expenses, depreciation, amortization, stock-based compensation, and common expense allocations.
We expect our sales and marketing expenses to increase for the foreseeable future as we continue to increase the size of our sales and marketing organization and expand into new markets. However, we expect our sales and marketing expenses to decrease slightly as a percentage of our total revenue over the near term. Our sales and marketing expenses may fluctuate as a percentage of our total revenue from period to period due to the seasonality of our total revenue and the timing and extent of our sales and marketing expenses.
Technology and development.    Technology and development expenses include personnel and related expenses for software engineering, information technology, security and compliance, and product development. Technology and development expenses also include outsourced software engineering services, the costs of operating our on-demand technology infrastructure, depreciation, amortization of capitalized software development costs, stock-based compensation, and common expense allocations.
We expect our technology and development expenses to increase for the foreseeable future as we continue to invest in the development of our proprietary system. We expect our technology and development expenses to increase as a percentage of our total revenue over the near term as a result of higher amortization costs related to our planned capital expenditures to improve the architecture of our proprietary system. Our technology and development expenses may fluctuate as a percentage of our total revenue from period to period due to the seasonality of our total revenue and the timing and extent of our technology and development expenses.
General and administrative.    General and administrative expenses include personnel and related expenses of, and professional fees incurred by, our executive, finance, legal, and people departments. They also include depreciation, amortization, stock-based compensation and common expense allocations.
We expect our general and administrative expenses to increase for the foreseeable future due to the additional legal, accounting, insurance, investor relations and other costs that we will incur as a newly public company, as well as other costs associated with continuing to grow our business. However, we expect our general and administrative expenses to remain steady as a percentage of our total revenue over the near term. Our general and administrative expenses may fluctuate as a percentage of our total revenue from period to period due to the seasonality of our total revenue and the timing and extent of our general and administrative expenses.
Amortization of acquired intangible assets.    Amortization of acquired intangible assets results from our acquisition of intangible member assets. We acquired these intangible member assets from third-party custodians. We amortize these assets over the assets’ estimated useful life of 15 years. We evaluate these assets for impairment each year.
Other expense
Other expense primarily consists of interest expense, loss on revaluation of warrants and loss on revaluation of our derivative liability associated with our series D-3 redeemable convertible preferred stock. We continued to record adjustments to the fair value of the derivative liability associated with our series D-3 redeemable convertible preferred stock until March 31, 2014, at which time the remeasurements ceased. As a result, during the six months ended July 31, 2014, we recorded a loss on revaluation of this derivative liability. However, as a result of our modifications of our series D-3 redeemable convertible preferred stock on March 31, 2014, we reclassified the aggregate fair value of the derivative liability associated with our series D-3 redeemable convertible preferred stock to additional paid-in capital and we ceased to record any related fair value adjustments.

-22-


Income tax provision
We are subject to federal and state income taxes in the United States based on a calendar tax year that differs from our fiscal year-end for financial reporting purposes. We use the asset and liability method to account for income taxes, under which current tax liabilities and assets are recognized for the estimated taxes payable or refundable on the tax returns for the current fiscal year. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, net operating loss carryforwards, and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. As of July 31, 2014, we remain in a net deferred tax liability position. Valuation allowances are established when necessary to reduce net deferred tax assets to the amount expected to be realized. Due to the positive evidence of taxable income coupled with forecasted profitability, no valuation allowance was required as of July 31, 2014.

Results of operations
The following table sets forth our results of operations for the specified periods. The period-to-period comparisons of results are not necessarily indicative of results for future periods.


Three months ended July 31,
 

Six months ended July 31,
 
(in thousands)

2014


2013


2014


2013

Revenue








Account fee revenue

$
10,548


$
7,209


$
20,936


$
14,225

Custodial fee revenue

5,934


4,648


11,361


9,097

Card fee revenue

4,233


3,014


8,531


6,076

Other revenue

176


111


294


208

Total revenue

20,891


14,982


41,122


29,606

Cost of services








Account costs

6,703


4,705


13,131


9,700

Custodial costs

1,006


910


1,944


1,879

Card costs

1,412


1,009


2,817


1,983

Other costs

1


15


2


42

Total cost of services

9,122


6,639


17,894


13,604

Gross profit

11,769


8,343


23,228


16,002

Operating expenses








Sales and marketing

2,321


1,837


4,554


3,582

Technology and development

2,302


1,659


4,488


3,328

General and administrative

1,666


825


2,809


1,735

Amortization of acquired intangible assets

409


409


818


818

Total operating expenses

6,698


4,730


12,669


9,463

Income from operations

5,071


3,613


10,559


6,539

Other expense








Interest expense



(10
)



(20
)
Loss on revaluation of warrants





(735
)


Other expense, net

(39
)

(30
)

(131
)

(103
)
Total other expense

(39
)

(40
)

(866
)

(123
)
Income before income taxes

5,032


3,573


9,693


6,416

Income tax provision

2,004


1,351


3,947


2,444

Net income and comprehensive income

$
3,028


$
2,222


$
5,746


$
3,972


-23-


The following table presents the components of our results of operations for the periods indicated as a percent of our total revenue:


Three months ended July 31,
 

Six months ended July 31,
 


2014


2013


2014


2013

Revenue








Account fee revenue

51
 %

48
 %

51
 %

48
 %
Custodial fee revenue

28
 %

31
 %

27
 %

31
 %
Card fee revenue

20
 %

20
 %

21
 %

20
 %
Other revenue

1
 %

1
 %

1
 %

1
 %
Total revenue