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EX-31.1 - 302 CEO CERTIFICATION - HEALTHEQUITY, INC.exhibit3112015-10x31.htm
EX-10.1 - EXHIBIT 10.1 - HEALTHEQUITY, INC.a101-hqyxsecondamendedandr.htm
EX-32.2 - 906 CFO CERTIFICATION - HEALTHEQUITY, INC.exhibit3222015-10x31.htm
EX-31.2 - 302 CFO CERTIFICATION - HEALTHEQUITY, INC.exhibit3122015-10x31.htm
EX-32.1 - 906 CEO CERTIFICATION - HEALTHEQUITY, INC.exhibit3212015-10x31.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 October 31, 2015
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.
 
 
 
(Exact name of registrant as specified in its charter)
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
(Address of principal executive offices) (Zip code)

(801) 727-1000
(Registrant's telephone Number, including Area Code)
 

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 þ No ¨

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 November 30, 2015, there were 57,626,846 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)
October 31, 2015


January 31, 2015

Assets



Current assets



Cash and cash equivalents
$
85,009


$
111,005

Marketable securities, at fair value
40,105



Total cash, cash equivalents and marketable securities
125,114


111,005

Accounts receivable, net of allowance for doubtful accounts of $34 as of October 31, 2015 and $40 as of January 31, 2015
9,922


9,054

Inventories
815


625

Deferred tax asset
2,035


1,764

Other current assets
3,332


2,271

Total current assets
141,218


124,719

Property and equipment, net
3,614


2,577

Intangible assets, net
61,036


26,541

Goodwill
4,651


4,651

Other assets
1,444


281

Total assets
$
211,963


$
158,769

Liabilities and stockholders’ equity



Current liabilities



Accounts payable
$
2,412


$
1,303

Accrued compensation
3,898


5,301

Accrued liabilities
3,053


2,227

Total current liabilities
9,363


8,831

Long-term liabilities



Other long-term liability
195


488

Deferred tax liability
4,080


5,355

Total long-term liabilities
4,275


5,843

Total liabilities
13,638


14,674

Commitments and contingencies (see note 5)



Stockholders’ equity



Preferred stock, $0.0001 par value, 100,000 shares authorized, no shares issued and outstanding as of October 31, 2015 and January 31, 2015, respectively



Common stock, $0.0001 par value, 900,000 shares authorized, 57,519 and 54,802 shares issued and outstanding as of October 31, 2015 and January 31, 2015, respectively
6


5

Additional paid-in capital
197,905


157,094

Accumulated other comprehensive loss
(67
)


Accumulated earnings (deficit)
481


(13,004
)
Total stockholders’ equity
198,325


144,095

Total liabilities and stockholders’ equity
$
211,963


$
158,769

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)
(in thousands, except per share data)
Three months ended October 31,
 

Nine months ended October 31,
 
2015


2014


2015


2014

Revenue:







   Account fee revenue
$
15,042


$
11,086


$
44,043


$
32,022

   Custodial fee revenue
9,142


6,196


26,592


17,557

   Card fee revenue
6,213


4,317


19,801


12,848

   Other revenue
159


263


464


557

   Total revenue
30,556


21,862


90,900


62,984

 Cost of services:







   Account costs
9,276


7,057


25,981


20,188

   Custodial costs
1,536


1,050


4,471


2,994

   Card costs
1,949


1,467


6,100


4,284

   Other costs
119


56


181


58

   Total cost of services
12,880


9,630


36,733


27,524

 Gross profit
17,676


12,232


54,167


35,460

 Operating expenses:







   Sales and marketing
3,067


2,275


8,637


6,829

   Technology and development
4,419


2,811


11,941


7,299

   General and administrative
3,477


2,443


10,578


5,252

   Amortization of acquired intangible assets
409


409


1,227


1,227

   Total operating expenses
11,372


7,938


32,383


20,607

 Income from operations
6,304


4,294


21,784


14,853

 Other income and (expense):







Loss on revaluation of redeemable convertible preferred stock derivative






(735
)
   Other income and (expense), net
121


(145
)

(526
)

(276
)
 Total other income and (expense)
121


(145
)

(526
)

(1,011
)
 Income before income taxes
6,425


4,149


21,258


13,842

 Income tax provision
2,338


1,100


7,773


5,047

 Net income
$
4,087


$
3,049


$
13,485


$
8,795

Net income attributable to common stockholders:







 Basic
$
4,087


$
3,020


$
13,485


$
10,245

 Diluted
$
4,087


$
3,036


$
13,485


$
9,530

Net income per share attributable to common stockholders:







 Basic
$
0.07


$
0.06


$
0.24


$
0.44

 Diluted
$
0.07


$
0.05


$
0.23


$
0.19

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







 Basic
57,353


53,678


56,397


23,232

 Diluted
59,263


57,553


58,664


50,052

Comprehensive income:







Net income
$
4,087


$
3,049


$
13,485


$
8,795

Other comprehensive loss:







Unrealized loss on available-for-sale marketable securities, net of tax
(34
)



(67
)


Comprehensive income
$
4,053


$
3,049


$
13,418


$
8,795

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

-4-


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

Nine months ended October 31,
 
(in thousands)
2015


2014

 Cash flows from operating activities:



 Net income
$
13,485


$
8,795

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



 Depreciation and amortization
5,730


4,187

 Loss on revaluation of redeemable convertible preferred stock derivative


735

 Deferred taxes
(1,505
)

2,026

 Stock-based compensation
4,254


793

 Changes in operating assets and liabilities:





 Accounts receivable
(868
)

(349
)
 Inventories
(190
)

(365
)
 Other assets
(1,421
)

(2,124
)
 Accounts payable
415


(1,542
)
 Accrued compensation
(1,403
)

(1,125
)
 Accrued liabilities
568


(540
)
 Other long-term liability
(293
)

88

 Net cash provided by operating activities
18,772


10,579

 Cash flows from investing activities:



 Purchases of marketable securities
(40,213
)


 Purchase of property and equipment
(1,882
)

(1,477
)
 Purchase of software and capitalized software development costs
(4,757
)

(4,851
)
 Purchase of other investments
(500
)

(305
)
 Acquisition of intangible member assets
(33,821
)


 Net cash used in investing activities
(81,173
)

(6,633
)
 Cash flows from financing activities:



Dividend payments


(50,347
)
Proceed from initial public offering, net of payment for offering costs


132,587

Proceeds from follow-on offering, net of payments for offering costs
23,492



Proceeds from exercise of common stock options
1,751


2,397

Proceeds from exercise of common stock warrants


2,380

Tax benefit from exercise of common stock options
11,315


2,974

Deferred financing costs paid
(153
)


 Net cash provided by financing activities
36,405


89,991

 (Decrease) increase in cash and cash equivalents
(25,996
)

93,937

 Beginning cash and cash equivalents
111,005


13,917

 Ending cash and cash equivalents
$
85,009


$
107,854

Supplemental disclosures of non-cash investing and financing activities:



Purchases of property and equipment included in accounts payable or accrued liabilities at period end
$
221


$

Purchases of software and capitalized software development costs included in accounts payable or accrued liabilities at period end
215



Deferred financing costs
150



Conversion of preferred stock to common stock


50,822

Preferred stock accretion


4,021

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


6,917

Common stock warrants exercised
$


$
2,334

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

-5-


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, HEQ Insurance Services, Inc., and HealthEquity Advisors, LLC (collectively referred to as the "Company").
During the year ended January 31, 2015, the Company and an unrelated company formed a limited partnership for investment in and the management of early stage companies in the healthcare industry. The Company has a 22% ownership interest in such partnership accounted for using the equity method of accounting. The investment was approximately $281,000 as of October 31, 2015 and is included in other assets on the accompanying condensed consolidated balance sheet.
During the three months ended October 31, 2015, the Company purchased an approximate 2% ownership interest in a limited partnership that engages in the development of technology-based financial healthcare products. The Company determined there was no significant influence and therefore the investment was accounted for using the cost method of accounting. The investment was $500,000 as of October 31, 2015 and is included in other assets on the accompanying condensed consolidated balance sheet.
All significant intercompany balances and transactions have been eliminated.
Basis of presentation—The accompanying condensed consolidated financial statements as of October 31, 2015 and for the three and nine months ended October 31, 2015 and 2014 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 Annual Report on Form 10-K for the year ended January 31, 2015. The fiscal year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.
Follow-on offering—On May 11, 2015, the Company closed its follow-on public offering and sold 972,500 shares of common stock at a public offering price of $25.90 per share, less the underwriters' discount. Certain selling stockholders sold 3,455,000 shares of common stock in the offering, including 380,000 shares of common stock which were issued upon the exercise of outstanding options. The Company received net proceeds of approximately $23.5 million after deducting underwriting discounts and commissions of approximately $1.0 million and other offering expenses payable by the Company of approximately $688,000. The Company did not receive any proceeds from the sale of shares by the selling stockholders other than $222,000 representing the exercise price of the options that were exercised in connection with the offering.
Marketable securities—Marketable securities consist primarily of mutual funds invested in corporate bonds, U.S. government agency securities, U.S. treasury bills, commercial paper, certificates of deposit, municipal notes, and bonds with original maturities beyond three months at the time of purchase. Marketable securities are classified as available-for-sale, held-to-maturity, or trading at the date of purchase. As of October 31, 2015, all marketable securities have been classified as available-for-sale. The Company may sell these securities at any time for use in current operations or for other purposes even if they have not yet reached maturity. As a result, the Company classifies its marketable securities, including securities with maturities beyond twelve months, as current assets in the accompanying condensed consolidated balance sheets. All marketable securities are recorded at their estimated fair value. Unrealized gains and losses for available-for-sale securities are recorded in other

-6-


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

Note 1. Summary of business and significant accounting policies (continued)


comprehensive income. The Company evaluates its marketable securities to assess whether those with unrealized loss positions are other-than-temporarily impaired. The Company considers impairments to be other than temporary if they are related to deterioration in credit risk or if it is likely it will sell the securities before the recovery of their cost basis. Realized gains and losses and declines in value judged to be other-than-temporary are determined based on the specific identification method and are reported in other expense, net in the condensed consolidated statements of operations and comprehensive income.
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 GAAP when it becomes effective. In July 2015, the FASB voted to defer the effective date to fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption beginning for fiscal years, and interim periods within those fiscal years, beginning after December 31, 2016. 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.
In April 2015, the FASB issued ASU 2015-3, Interest - Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs, which simplifies the presentation of debt issuance costs by requiring that such costs be presented as a deduction from the corresponding debt liability. In August 2015, the FASB issued ASU 2015-15, Interest - Imputed Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, which clarifies that entities may continue to defer and present debt issuance costs associated with a line-of-credit as an asset and subsequently amortize the deferred costs ratably over the term of the arrangement. The guidance is effective for financial statements issued for reporting periods beginning after December 15, 2015 and interim periods within the reporting periods and requires retrospective presentation; earlier adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial condition, results of operations or cash flows.
In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, which simplifies balance sheet classifications of deferred taxes by requiring all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. The net current deferred tax asset as of October 31, 2015 was $2.0 million. The Company plans to early adopt this guidance on a prospective basis in the first quarter of fiscal year 2017.
Asset acquisitions—In October 2015, the Company acquired a portfolio of HSAs. The Company paid $33.8 million in cash, which was funded by cash on hand. The purchased group of assets did not include workforce or any processes and therefore did not constitute a business. Accordingly, the acquisition was accounted for under the asset acquisition method of accounting in accordance with ASC 805-50, Business Combinations—Related Issues. Under the asset acquisition method of accounting, the Company is required to fair value the assets transferred. The costs of the assets acquired is allocated to the individual assets acquired based on their relative fair values and does not give rise to goodwill. As of October 31, 2015, the purchase price of $33.8 million was allocated to acquired intangible member assets. Furthermore, transaction costs that are incurred in conjunction with an asset acquisition are allocated to the acquired intangible member assets.
Business Combinations—Acquisition-related expenses incurred in conjunction with the acquisition of a business as defined by ASC 805-10 are recognized in earnings in the period in which they are incurred and are included in other expense, net on the condensed consolidated statement of operations. During the three and nine months ended October 31, 2015, the Company received a credit of $187,000 and incurred an expense of $474,000, respectively for acquisition-related activity. There were no such business combinations during the three and nine months ended October 31, 2015 and 2014.


-7-


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

Note 2. Net income per share attributable to common stockholders

The Company computed net income per share of common stock in conformity with the two-class method required for participating securities for the nine months ended October 31, 2014. Prior to their conversion to common stock, the Company considered its series D-3 redeemable convertible preferred stock to be participating securities as the holders of the preferred stock were entitled to receive a dividend in the event that a dividend was paid on common stock. The following table sets forth the computation of basic and diluted net income per share attributable to common stockholders:
(in thousands, except per share data)

Three months ended October 31,
 

Nine months ended October 31,
 

2015


2014


2015


2014

Numerator (basic and diluted):








Net income

$
4,087


$
3,049


$
13,485


$
8,795

Add back: accretion of redeemable convertible preferred stock







4,021

Less: dividend on redeemable convertible preferred stock and dividend on convertible preferred stock



(21
)



(1,286
)
Less: undistributed income attributed to redeemable convertible preferred stockholders



(8
)



(1,285
)
Net income attributable to common stockholders for basic earnings per share

$
4,087


$
3,020


$
13,485


$
10,245

Add back: dividend of redeemable convertible preferred stock



15




1,286

Less: accretion on redeemable convertible preferred stock and dividend on convertible preferred stock







(4,021
)
Add back: series D-3 derivative liability revaluations







735

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



1




1,285

Net income attributable to common stockholders for diluted earnings per share

$
4,087


$
3,036


$
13,485


$
9,530










Denominator (basic):








Weighted-average common shares outstanding

57,353


53,678


56,397


23,232

Denominator (diluted):








Weighted-average common shares outstanding

57,353


53,678


56,397


23,232

Effect of potential dilutive securities:








Weighted-average dilutive effect of stock options

1,910


2,944


2,267


3,290

Weighted-average dilutive effect of common shares from stock warrants



3




1,634

Dilutive effect from preferred stock assuming conversion



928




21,896

Weighted-average common shares outstanding

59,263


57,553


58,664


50,052

Net income per share attributable to common stockholders:








Basic

$
0.07


$
0.06


$
0.24


$
0.44

Diluted

$
0.07


$
0.05


$
0.23


$
0.19



-8-


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

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


For the three months ended October 31, 2015 and 2014, approximately 817,000 and 322,000 shares, respectively, attributable to stock options were excluded from the calculation of diluted earnings per share as their inclusion would have been anti-dilutive.
For the nine months ended October 31, 2015 and 2014, approximately 726,000 and 164,000 shares, respectively, attributable to 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 October 31, 2015 and January 31, 2015:
(in thousands)

October 31, 2015


January 31, 2015

Leasehold improvements

$
703


$
506

Furniture and fixtures

1,555


1,317

Computer equipment

5,681


4,013

Property and equipment, gross

7,939


5,836

Accumulated depreciation

(4,325
)

(3,259
)
Property and equipment, net

$
3,614


$
2,577

Depreciation expense for the three and nine months ended October 31, 2015 was $389,000 and $1.1 million, respectively, and $290,000 and $776,000 for the three and nine months ended October 31, 2014, respectively.

-9-


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

Note 4. Intangible assets and goodwill

During the three months ended October 31, 2015, the Company acquired an HSA portfolio for $33.8 million. The cost, including transaction costs, was allocated to acquired intangible member assets as of October 31, 2015. The Company has determined the acquired intangible member assets to have a useful life of 15 years. The assets will be amortized using the straight-line amortization method, which has been determined appropriate to reflect the pattern over which the economic benefits of existing member assets are realized.
During the three and nine months ended October 31, 2015, the Company capitalized software development costs of $1.5 million and $4.0 million, respectively, and $1.4 million and $3.8 million for the three and nine months ended October 31, 2014, respectively, related to significant enhancements and upgrades to its proprietary system.
The gross carrying amount and associated accumulated amortization of intangible assets were as follows as of October 31, 2015 and January 31, 2015:
(in thousands)

October 31, 2015


January 31, 2015

Amortized intangible assets:




Capitalized software development costs

$
14,432


$
10,468

Software

5,703


4,695

Acquired intangible member assets

58,750


24,563

Intangible assets, gross

78,885


39,726

Accumulated amortization

(17,849
)

(13,185
)
Intangible assets, net

$
61,036


$
26,541

During the three and nine months ended October 31, 2015, the Company incurred and expensed a total of $2.0 million and $5.4 million, respectively, and $1.2 million and $3.2 million for the three and nine months ended October 31, 2014, respectively, in software development costs primarily related to the post-implementation and operation stages of its proprietary software.
Amortization expense for the three and nine months ended October 31, 2015 was $1.7 million and $4.7 million, respectively, and $1.3 million and $3.4 million for the three and nine months ended October 31, 2014, respectively.
There were no changes to the goodwill carrying value during the three and nine months ended October 31, 2015 and 2014.

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, 2015 are disclosed in the Company’s consolidated financial statements included in its Annual Report on Form 10-K for the year ended January 31, 2015, and did not change materially during the three and nine months ended October 31, 2015, except for the following:
On May 15, 2015, the Company entered into a lease agreement to expand its headquarters in Draper, Utah. The lease provides for a new landlord to construct a building at its cost and to use reasonable efforts to substantially complete the building by July 2016. The Company has no risk of loss during the construction period. The lease will commence upon the substantial completion and delivery of the building to the Company and has an initial term of 129 months thereafter, with a Company option to extend the lease for two additional five year periods. The Company will be responsible for payment of taxes and operating expenses for its portion of the building, in addition to an annual base rent in the initial amount of approximately $1.0 million, with 2.5% annual increases. In conjunction with the aforementioned lease, the Company entered into an amended and restated lease agreement for its existing office space at its headquarters in Draper, Utah. The lease commenced on July 1, 2015 and has an initial term of 129 months thereafter, with a Company option to extend the lease for two additional five year periods. The

-10-


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

Note 5. Commitments and contingencies (continued)


Company will be responsible for payment of taxes and operating expenses for its portion of the building, in addition to an annual base rent in the initial amount of approximately $1.6 million, with 2.5% annual increases. As a result of the foregoing transaction, the deferred rent balance of approximately $470,000 was reversed during the nine months ended October 31, 2015.
Lease expense for office space for the three and nine months ended October 31, 2015 was $556,000 and $1.6 million, respectively, and $374,000 and $944,000 for the three and nine months ended October 31, 2014, respectively. Expense for other lease agreements for the three and nine months ended October 31, 2015 was $66,000 and $182,000, respectively, and $67,000 and $166,000 for the three and nine months ended October 31, 2014, respectively.

Note 6. Indebtedness

On September 30, 2015, the Company entered into a new credit facility (the "Credit Agreement"). The Credit Agreement provides for a secured revolving credit facility in the aggregate principal amount of $100.0 million for a term of five years. The proceeds of borrowings under the Credit Agreement may be used for general corporate purposes. No amounts have been drawn under the Credit Agreement as of October 31, 2015.
Borrowings under the Credit Agreement bear interest equal to, at the Company's option, a) an adjusted LIBOR rate or b) a customary base rate, in each case with an applicable spread to be determined based on the Company's leverage ratio as of the most recent fiscal quarter. The applicable spread for borrowing under the Credit Agreement will range from 1.50% to 2.00% with respect to adjusted LIBOR rate borrowings and 0.50% to 1.00% with respect to customary base rate borrowings. Additionally, the Company will pay a commitment fee ranging from 0.20% to 0.30% on the daily amount of the unused commitments under the Credit Agreement payable in arrears at the end of each fiscal quarter.
The Company's material subsidiaries will be required to guarantee the obligations of the Company under the Credit Agreement. The obligations of the Company and the guarantors under the Credit Agreement and the guarantees will be secured by substantially all assets of the Company and the guarantors, subject to customary exclusions and exceptions.
The Credit Agreement requires the Company to maintain a total leverage ratio of not more than 3.00 to 1.00 as of the end of each fiscal quarter and a minimum interest coverage ratio of at least 3.00 to 1.00 as of the end of each fiscal quarter. In addition, the Credit Agreement includes customary representations and warranties, affirmative and negative covenants, and events of default. The restrictive covenants include customary restrictions on the Company's ability to incur additional indebtedness; make investments, loans or advances; grant or incur liens on assets; engage in mergers, consolidations, liquidations or dissolutions; engage in transactions with affiliates; and make dividend payments.
In connection with the Credit Agreement, the Company incurred $303,000 in financing costs, which are deferred and are being amortized using the straight-line method, which approximates the effective interest method, over the life of the agreement.

Note 7. 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 nine months ended October 31, 2015, the Company recorded a provision for income taxes of $2.3 million and $7.8 million, respectively. The resulting effective tax rate was 36.4% and 36.6%, compared with an effective tax rate of 26.5% and 36.5% for the three and nine months ended October 31, 2014. For the three and nine months ended October 31, 2015, discrete tax items were not significant. For the three and nine

-11-


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

Note 7. Income taxes (continued)


months ended October 31, 2014, the net impact of discrete tax items caused a 12.1% and 3.1% decrease, respectively, to the effective tax rate primarily due to the recognition of research and development tax credits, book stock compensation expense on stock options vesting upon the Company's initial public offering, or IPO, treated as a discrete event, and the impact of changes in estimated annual tax rates. The federal research and development tax credit expired as of December 31, 2014.
As of October 31, 2015 and January 31, 2015, the Company’s total gross unrecognized tax benefit was $329,000 and $300,000, 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 October 31, 2015 and January 31, 2015 remains unchanged at $20,000. If recognized, $248,000 of the total gross unrecognized tax benefits would affect the Company's effective tax rate as of October 31, 2015. The Company anticipates a decrease of $20,000 in total gross unrecognized tax benefits within 12 months of the reporting date related to uncertain tax positions on research and development credits claimed and the untimely filing of certain elections 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 2003.

-12-


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

Note 8. Stock options

Stock option activity under the Company's equity incentive plans 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, 2015

6,457


$0.10 - 25.45

$
5.27


6.88

$
100,290

Granted

972


$25.39 - 28.69

$
26.58





Exercised

(1,743
)

$0.10 - 18.93

$
1.00





Forfeited

(153
)

$0.80 - 26.66

$
17.31





Outstanding as of October 31, 2015

5,533


$0.10 - 28.69

$
10.02


7.15

$
125,550

Vested and expected to vest as of October 31, 2015

5,319




$
9.72


7.08

$
122,313

Exercisable as of October 31, 2015

2,615




$
2.09


5.22

$
80,095

The aggregate intrinsic value in the table above represents the difference between the estimated fair value of common stock and the exercise price of outstanding, in-the-money stock options.
The key input assumptions that were utilized in the valuation of the stock options granted during the periods presented:
  

Three months ended October 31,
 

Nine months ended October 31,
  

2015


2014


2015


2014
Expected dividend yield

%

%

%

—%
Expected stock price volatility

38.4
%

32.9
%

38.4% - 40.3%


32.9%
Risk-free interest rate

1.56% - 1.70%


1.93
%

1.47% - 1.72%


1.93% - 2.24%
Expected life of options

6.25 years


6.25 years


5.43 - 6.25 years


6.25 years
The determination of the fair value of stock options on the date of grant using an option pricing model is affected by the Company's stock price as well as assumptions regarding a number of complex and subjective variables. Expected volatility is determined using weighted average volatility of publicly traded peer companies. The Company expects that it will begin using its own historical volatility in addition to the volatility of publicly traded peer companies, as its share price history grows over time. The risk-free interest rate is determined by using published zero coupon rates on treasury notes for each grant date given the expected term on the options. The dividend yield of zero is based on the fact that the Company expects to invest cash in operations. The Company uses the "simplified" method to estimate expected term as determined under Staff Accounting Bulletin No. 110 due to the lack of sufficient option exercise history as a public company.
As of October 31, 2015, the weighted-average vesting period of non-vested awards expected to vest approximates 2.6 years; the amount of compensation expense the Company expects to recognize for stock options vesting in future periods approximates $14.7 million.


-13-


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

Note 8. Stock options (continued)


The following table shows a summary of stock-based compensation in the Company's condensed consolidated statements of operations and comprehensive income during the periods presented:


Three months ended October 31,
 

Nine months ended October 31,
 
(in thousands)

2015


2014


2015


2014

Cost of services

$
304


$
24


$
740


$
94

Sales and marketing

218


4


705


145

Technology and development

290


31


677


116

General and administrative

671


268


2,132


438

Total stock-based compensation expense

$
1,483


$
327


$
4,254


$
793


Note 9. Cash, cash equivalents and marketable securities

Cash, cash equivalents and marketable securities as of October 31, 2015 consisted of the following:
(in thousands)
Cost basis


Gross unrealized gains


Gross unrealized losses


Fair value

Cash and cash equivalents
$
85,009


$


$


$
85,009

Marketable securities:







Mutual funds
40,213


36


(144
)

40,105

Total cash, cash equivalents and marketable securities
$
125,222


$
36


$
(144
)

$
125,114


Cash, cash equivalents and marketable securities as of January 31, 2015 consisted of the following:
(in thousands)
Cost basis


Gross unrealized gains


Gross unrealized losses


Fair value

Cash and cash equivalents
$
111,005


$


$


$
111,005

Marketable securities:







Mutual funds







Total cash, cash equivalents and marketable securities
$
111,005


$


$


$
111,005


The following table summarizes the cost basis and fair value of the marketable securities by contractual maturity as of October 31, 2015:
(in thousands)
Cost basis


Fair value

One year or less
$
25,095


$
25,070

Over one year and less than five years
15,118


15,035

Total
$
40,213


$
40,105


As of October 31, 2015, there were no marketable securities that were other-than-temporarily impaired or in an unrealized loss position for more than twelve consecutive months.



-14-


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

Note 10. Fair value

Fair value measurements—Fair value measurements are made at a specific point in time, based on relevant market information. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Accounting standards specify a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs have created the following fair value hierarchy:

Level 1—quoted prices in active markets for identical assets or liabilities;
Level 2—inputs, other than the quoted prices in active markets, that are observable either directly or indirectly;
Level 3—unobservable inputs based on the Company’s own assumptions.

Level 1 instruments are valued based on publicly available daily net asset values. Level 1 instruments consist primarily of highly liquid mutual funds.

The following table summarizes the assets measured at fair value on a recurring basis and indicates the level within the fair value hierarchy reflecting the valuation techniques utilized to determine fair value:


October 31, 2015
 
(in thousands)

Level 1


Level 2


Level 3

Marketable securities:







Mutual funds

$
40,105


$


$

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 was recorded at its fair value, using an option pricing model, and was adjusted to fair value as of the end of each reporting period. Changes in the fair value of derivative instruments are recognized currently in the condensed consolidated financial statements. The Company had 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 nine months ended October 31, 2015 and 2014 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 October 31,
 

Nine months ended October 31,
 
(in thousands)

2015


2014


2015


2014

Balance at beginning of period

$


$


$


$
6,182

Loss on revaluation







735

Elimination of liability due to removal of FMV provision







(6,917
)
Balance at end of period

$


$


$


$




-15-


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

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. In connection with the consummation of the Company's IPO in July 2014, this consulting agreement was terminated and as such, no amounts were paid to this company for the three and nine months ended October 31, 2015. The amount paid to this company under the terms of the consulting agreement for the three and nine months ended October 31, 2014 was $0 and $162,000, respectively.





-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 in our Annual Report on Form 10-K for the year ended January 31, 2015 and in our other reports filed with the SEC. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such events.

Overview
We are a leader and an innovator in 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, which is 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 approximately 30,000 employer clients, including industry leaders such as Adobe Systems, 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 60 million consumers, representing approximately 34% 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 through our wholly-owned investment advisory subsidiary, HealthEquity Advisors, LLC.
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.


-17-


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 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 our insurance company partner, 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” included in our Annual Report on Form 10-K for the year ended January 31, 2015.
Structural change in U.S. private health insurance
Substantially all of our revenue is derived from healthcare-related saving and spending by consumers in the United States, which is impacted by changes affecting the broader healthcare industry in the U.S. 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, and, in any event, no assurance can be given that such growth will occur.
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 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 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 realize. Conversely, a

-18-


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.
Our competition and industry
Our direct competitors are HSA custodians, of which there are over 2,200 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, the Internal Revenue Code and 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 the 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, or the Advisers Act, 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.
Our acquisition strategy
We have a successful history of acquiring complementary assets and businesses that strengthen our platform, which is evidenced by our recent HSA portfolio acquisition during the three months ended October 31, 2015. We expect to continue this growth strategy and are regularly engaged in evaluating different opportunities. We have developed an internal capability to source, evaluate and integrate acquisitions that have created value for shareholders. We believe the nature of our competitive landscape provides a significant acquisition opportunity. Many of our competitors view their HSA businesses as non-core functions. We believe they will look to divest these assets and, in certain cases, be limited from making acquisitions due to depository capital requirements.
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. The key financial and operating metrics as of and for the three and nine months ended October 31, 2015 do not reflect any impact from our recent HSA portfolio acquisition that occurred during the three months ended October 31, 2015.
HSA members
The following table sets forth our HSA Members as of the periods indicated:


October 31, 2015


October 31, 2014


% Change


January 31, 2015

HSA Members

1,602,156


1,108,533


45
%

1,426,785

Average HSA Members - Year-to-date

1,516,821


1,040,531


46
%

1,087,962

Average HSA Members - Quarter-to-date

1,580,482


1,090,516


45
%

1,230,256

The number of our HSA Members is critical because our account fee revenue is driven by the administrative fees we charge per account.

-19-


The number of our HSA Members increased by approximately 494,000, or 45%, from October 31, 2014 to October 31, 2015, and by approximately 349,000, or 46%, from October 31, 2013 to October 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)

October 31, 2015


October 31, 2014


% Change


January 31, 2015

Cash AUM

$
2,307,914


$
1,578,814


46
%

$
2,075,741

Investment AUM

385,243


256,791


50
%

286,526

Total AUM

$
2,693,157


$
1,835,605


47
%

$
2,362,267

Average daily cash AUM - Year-to-date

$
2,207,732


$
1,505,659


47
%

$
1,553,845

Average daily cash AUM - Quarter-to-date

$
2,269,253


$
1,556,828


46
%

$
1,698,402

We define AUM as our custodial assets under management. Our AUM, which is our HSA Members' assets under management, consists of the following components: (1) cash deposit AUM which are deposits with our FDIC-insured custodial depository bank partners, (2) Cash AUM invested in an annuity contract with our insurance company partner and (3) members' investments 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 total AUM increased by $857.6 million, or 47%, from October 31, 2014 to October 31, 2015. Our total AUM increased by $537.8 million, or 41%, from October 31, 2013 to October 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 October 31,
 





Nine months ended October 31,
 




(in thousands, except percentages)

2015


2014


$ Change


% Change


2015


2014


$ Change


% Change

Adjusted EBITDA

$
9,851


$
6,065


$
3,786


62
%

$
31,767


$
19,736


$
12,031


61
%
As a percentage of revenue
 
32
%

28
%
 
 
 
 
 
35
%

31
%
 
 
 
 
We define Adjusted EBITDA, which is a non-GAAP financial metric, as adjusted earnings before interest, taxes, depreciation and amortization and certain other non-operating items. We believe that Adjusted EBITDA provides useful information to investors and analysts in understanding and evaluating our operating results in the same manner as our management and our board of directors because it reflects operating profitability before consideration of non-operating expenses and non-cash expenses, and serves as a basis for comparison against other companies in our industry.
Our Adjusted EBITDA increased by $3.8 million, or 62%, from $6.1 million for the three months ended October 31, 2014 to $9.9 million for the three months ended October 31, 2015. The increase in Adjusted EBITDA was driven by the overall growth of our business, including a $2.0 million, or 47%, increase in income from operations.
Our Adjusted EBITDA increased by $12.0 million, or 61%, from $19.7 million for the nine months ended October 31, 2014 to $31.8 million for the nine months ended October 31, 2015. The increase in Adjusted EBITDA was driven by the overall growth of our business, including a $6.9 million, or 47%, 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.

-20-


The following table presents a reconciliation of net income, the most comparable GAAP financial measure, to Adjusted EBITDA for each of the periods indicated:


Three months ended October 31,
 

Nine months ended October 31,
 
(in thousands)

2015


2014


2015


2014

Net income

$
4,087


$
3,049


$
13,485


$
8,795

Interest expense

23




23



Income tax provision

2,338


1,100


7,773


5,047

Depreciation and amortization

1,656


1,134


4,503


2,960

Amortization of acquired intangible assets

409


409


1,227


1,227

Loss on revaluation of redeemable convertible preferred stock derivative liability







735

Stock-based compensation expense

1,483


327


4,254


793

Other (1)

(145
)

46


502


179

Total adjustments

$
5,764


$
3,016


$
18,282


$
10,941

Adjusted EBITDA

$
9,851


$
6,065


$
31,767


$
19,736

(1)
For the three months ended October 31, 2015 and 2014, Other consisted of interest income of $(116) and $(9), miscellaneous taxes of $77 and $55, acquisition-related costs of $(187) and $0, and SEC registration costs of $81 and $0, respectively. For the nine months ended October 31, 2015 and 2014, Other consisted of interest income of $(302) and $(9), miscellaneous taxes of $249 and $188, acquisition-related costs of $474 and $0, and SEC registration costs of $81 and $0, respectively.
Key components of our results of operations
Revenue
The following table sets forth our revenue for the periods indicated:


Three months ended October 31,
 





Nine months ended October 31,
 




(in thousands, except percentages)

2015


2014


$ Change


% Change


2015


2014


$ Change


% Change

Account fee revenue

$
15,042


$
11,086


$
3,956


36
 %

$
44,043


$
32,022


$
12,021


38
 %
Custodial fee revenue

9,142


6,196


2,946


48
 %

26,592


17,557


9,035


51
 %
Card fee revenue

6,213


4,317


1,896


44
 %

19,801


12,848


6,953


54
 %
Other revenue

159


263


(104
)

(40
)%

464


557


(93
)

(17
)%
Total revenue

$
30,556


$
21,862


$
8,694


40
 %

$
90,900


$
62,984


$
27,916


44
 %
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 HSAs and Health Reimbursement Arrangements ("HRA") we offer. Our fees are generally based on a tiered structure 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 fee revenue from our AUM held in trust with our FDIC-insured custodial depository bank partners, our insurance company partner 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 held in trust 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

-21-


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 (such as office rent, supplies, and other overhead expenses) 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, which is 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.
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, on an annual basis, 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. On an annual basis, 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, and professional fees incurred by our executive, finance, legal, and people departments. They also include depreciation, amortization, stock-based compensation and common expense allocations.

-22-


We expect our general and administrative expenses to increase for the foreseeable future due to the additional legal, accounting, insurance, investor relations and other public company costs that we continue to incur as a new public company, as well as other costs associated with continuing to grow our business. Looking forward, on an annual basis we expect our general and administrative expenses to increase 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 at least each year, or at a triggering event. Our amortization of acquired intangible assets will increase going forward due to the acquisition of the HSA portfolio which occurred during the three months ended October 31, 2015. The acquired HSA portfolio will be amortized using the straight-line method over an estimated useful life of 15 years.
Other income and expense
Other expense primarily consists of interest expense associated with our credit facility, miscellaneous taxes, acquisition-related expenses, 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 nine months ended October 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.
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 October 31, 2015, we remain in a net deferred tax liability position. In accordance with FASB ASC 718-740-25-10, Compensation - Stock Compensation, a portion of deferred tax assets attributable to excess stock option benefits is tracked separately and is not included in the recorded deferred tax asset. As of October 31, 2015, deferred tax assets attributable to excess stock option benefits totaled $5.3 million. Such benefit will not be recorded until the deduction reduces cash taxes payable. 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 historical profits coupled with forecasted profitability, no valuation allowance was required as of October 31, 2015.


-23-


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 October 31,
 

Nine months ended October 31,
 
(in thousands)

2015


2014


2015


2014

Revenue








Account fee revenue

$
15,042


$
11,086


$
44,043


$
32,022

Custodial fee revenue

9,142


6,196


26,592


17,557

Card fee revenue

6,213


4,317


19,801


12,848

Other revenue

159


263


464


557

Total revenue

30,556


21,862


90,900


62,984

Cost of services








Account costs

9,276


7,057


25,981


20,188

Custodial costs

1,536


1,050


4,471


2,994

Card costs

1,949


1,467


6,100


4,284

Other costs

119


56


181


58

Total cost of services

12,880


9,630


36,733


27,524

Gross profit

17,676


12,232


54,167


35,460

Operating expenses








Sales and marketing

3,067


2,275


8,637


6,829

Technology and development

4,419


2,811


11,941


7,299

General and administrative

3,477


2,443


10,578


5,252

Amortization of acquired intangible assets

409


409


1,227


1,227

Total operating expenses

11,372


7,938


32,383


20,607

Income from operations

6,304


4,294


21,784


14,853

Other income and (expense)








Loss on revaluation of redeemable convertible preferred stock derivative







(735
)
Other income and (expense), net

121


(145
)

(526
)

(276
)
Total other income and (expense)

121


(145
)

(526
)

(1,011
)
Income before income taxes

6,425


4,149


21,258


13,842

Income tax provision

2,338


1,100


7,773


5,047

Net income

$
4,087


$
3,049


$
13,485


$
8,795


-24-


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 October 31,
 

Nine months ended October 31,
 


2015


2014


2015


2014

Revenue








Account fee revenue

49
%

51
 %

48
%

51
 %
Custodial fee revenue

30
%

28
 %

29
%

28
 %
Card fee revenue

20
%

20
 %

22
%

20
 %
Other revenue

1
%

1
 %

1
%

1
 %
Total revenue

100
%

100
 %

100
%

100
 %
Cost of services








Account costs

30
%

32
 %

28
%

32
 %
Custodial costs

5
%

5
 %

5
%

5
 %
Card costs

7
%

7
 %

7
%

7
 %
Other costs

%

 %

%

 %
Total cost of services

42
%

44
 %

40
%

44
 %
Gross profit

58
%

56
 %

60
%

56
 %
Operating expenses








Sales and marketing

10
%

10
 %

10
%

11
 %
Technology and development

15
%

13
 %

13
%

12
 %
General and administrative

11
%

11
 %

12
%

8
 %
Amortization of acquired intangible assets

1
%

2
 %

1
%

2
 %
Total operating expenses

37
%

36
 %

36
%

33
 %
Income from operations

21
%

20
 %

24
%

23
 %
Other income and (expense)








Loss on revaluation of redeemable convertible preferred stock derivative

%

 %

%

(1
)%
Other income and (expense), net

%

(1
)%

%

 %
Total other income and (expense)

%

(1
)%

%

(1
)%
Income before income taxes

21
%

19
 %

24
%

22
 %
Income tax provision

8
%

5
 %

9
%

8
 %
Net income

13
%

14
 %

15
%

14
 %
Comparison of the three and nine months ended October 31, 2015 and 2014
Account fee revenue
The $4.0 million increase in account fee revenue for the three months ended October 31, 2015 as compared to the three months ended October 31, 2014 was primarily due to an increase in the number of our HSA Members. The $12.0 million increase in account fee revenue for the nine months ended October 31, 2015 as compared to the nine months ended October 31, 2014 was primarily due to an increase in the number of our HSA Members. The number of our HSA Members increased by approximately 494,000, or 45%, from October 31, 2014 to October 31, 2015.
The growth in the number of our HSA Members from October 31, 2014 to October 31, 2015 was due to a combination of growth from our new and existing Network Partners.
Account fees per HSA Member decreased for the three and nine months ended October 31, 2015 as compared to the three and nine months ended October 31, 2014 by approximately 6%. Our account fee tier structure incentivizes Network Partners to add HSA Members by charging a lower rate for more HSA Members. As Network Partners add more HSA Members, the account fee per HSA Member will continue to decrease. The decrease in account fees per HSA Member were partially offset by increases in custodial fees per HSA Member.

-25-


Custodial fee revenue
The $2.9 million increase in custodial fee revenue from the three months ended October 31, 2014 to the three months ended October 31, 2015 was primarily due to an increase in average daily cash AUM of $712.4 million, or 46%, and an increase in the yield on average cash AUM from 1.52% for the three months ended October 31, 2014 to 1.55% for the three months ended October 31, 2015. Custodial fees increased for the three months ended October 31, 2015 as a percentage of our total revenue compared to the three months ended October 31, 2014, primarily due to higher-rate custodial depository agreements added subsequent to the three months ended October 31, 2014 to accommodate our growth in cash AUM. This had a positive impact on our interest yield for the three months ended October 31, 2015 compared to the three months ended October 31, 2014.
The $9.0 million increase in custodial fee revenue from the nine months ended October 31, 2014 to the nine months ended October 31, 2015 was primarily due to an increase in average daily cash AUM of $702.1 million, or 47%, and an increase in the yield on average cash AUM from 1.51% in the nine months ended October 31, 2014 to 1.56% in the nine months ended October 31, 2015. Custodial fees increased in the nine months ended October 31, 2015 as a percentage of our total revenue compared to the nine months ended October 31, 2014, primarily due to higher-rate custodial depository agreements added subsequent to the nine months ended October 31, 2014 to accommodate our growth in cash AUM. This had a positive impact on our interest yield during the nine months ended October 31, 2015 compared to the nine months ended October 31, 2014.
Custodial fees per HSA Member increased for the three and nine months ended October 31, 2015 as compared to the three and nine months ended October 31, 2014 by approximately 2% and 4%, respectively, primarily due to the higher yield and higher cash AUM balances.
Investment AUM increases resulted from an increase in the number of our members choosing to move their HSA assets from cash balances to investment balances, along with market changes (positive or negative) in the particular investments chosen.
Card fee revenue
The $1.9 million increase in card fee revenue from the three months ended October 31, 2014 to the three months ended October 31, 2015 was due to an overall increase in the number of our HSA Members and card activity. In addition, we continued to see a trend toward more HSA spending through payment card transaction swipes and less by checks and ACH or electronic reimbursements, which increased our card fee revenue. We began our efforts to increase card spend on our platform during the three months ended October 31, 2014, as a result our card fees per HSA Member remained steady during the three months ended October 31, 2015.
The $7.0 million increase in card fee revenue from the nine months ended October 31, 2014 to the nine months ended October 31, 2015 was due to an overall increase in the number of our HSA Members and card activity. In addition, our efforts to increase card spend on our platform has resulted in an increase in card fees per HSA Member for the nine months ended October 31, 2015 by approximately 6%.
Other revenue
Other revenue decreased $104,000 and $93,000 from the three and nine months ended October 31, 2014 to the three and nine months ended October 31, 2015, respectively. The fluctuation of other revenue was the result of changes in the amount of fees charged to our Network Partners for marketing materials.

Cost of services
The following table sets forth our cost of service for the periods indicated:
(in thousands, except percentages)

Three months ended October 31,
 





Nine months ended October 31,
 





2015


2014


$ Change


% Change


2015


2014


$ Change


% Change

Account costs

$
9,276


$
7,057


$
2,219


31
%

$
25,981


$
20,188


$
5,793


29
%
Custodial costs

1,536


1,050


486


46
%

4,471


2,994


1,477


49
%
Card costs

1,949


1,467


482


33
%

6,100


4,284


1,816


42
%
Other costs

119


56


63


113
%

181


58


123


212
%
Total cost

$
12,880


$
9,630


$
3,250


34
%

$
36,733


$
27,524


$
9,209


33
%
Account costs
The $2.2 million increase in account costs from the three months ended October 31, 2014 to the three months ended October 31, 2015 was due to the higher volume of total accounts being serviced. The $2.2 million increase

-26-


includes $1.0 million related to the hiring of additional personnel to implement and support our new Network Partners and HSA Members, activation and processing costs of $559,000 related to account and card activation as well as monthly processing of statements and other communications, stock compensation expense of $280,000, other expenses of $232,000, and depreciation and amortization of $105,000.
The $5.8 million increase in account costs from the nine months ended October 31, 2014 to the nine months ended October 31, 2015 was due to the higher volume of total accounts being serviced. The $5.8 million increase includes $3.4 million related to the hiring of additional personnel to implement and support our new Network Partners and HSA Members, activation and processing costs of $1.0 million related to account and card activation as well as monthly processing of statements and other communications, stock compensation expense of $645,000, depreciation and amortization of $298,000, information technology expenses of $215,000, and $182,000 in other expenses.
Custodial costs
Our custodial costs increased $486,000 from the three months ended October 31, 2014 compared to the three months ended October 31, 2015. Our custodial costs of 0.27% on average cash AUM remained steady from the three months ended October 31, 2014 to the three months ended October 31, 2015, while average cash AUM increased from $1.56 billion during the three months ended October 31, 2014 to $2.27 billion during the three months ended October 31, 2015.
Our custodial costs increased $1.5 million from the nine months ended October 31, 2014 compared to the nine months ended October 31, 2015. Our custodial costs of 0.27% on average cash AUM remained steady from the nine months ended October 31, 2014 to the nine months ended October 31, 2015, while average cash AUM increased from $1.51 billion during the nine months ended October 31, 2014 to $2.21 billion during the nine months ended October 31, 2015.
Card costs
Our card costs increased $482,000, or 33%, from the three months ended October 31, 2014 compared to the three months ended October 31, 2015. Our card costs increased $1.8 million, or 42%, from the nine months ended October 31, 2014 compared to the nine months ended October 31, 2015. The increase is a result of increases in card spend and RA spend increasing as a percentage of total spend.
As we continue to add HSA Members, our cost of services will increase in aggregate dollar amount to support our Network Partners and members. Cost of services will continue to be affected by a number of different factors, including our ability to implement new technology in our Member Education Center as well as scaling our Network Partner implementation and account management functions.
Operating expenses
The following table sets forth our operating expenses for the periods indicated:
(in thousands, except percentages)

Three months ended October 31,
 





Nine months ended October 31,
 





2015


2014


$ Change


% Change


2015


2014


$ Change


% Change

Sales and marketing

$
3,067


$
2,275


$
792


35
%

$
8,637


$
6,829


$
1,808


26
%
Technology and development

4,419


2,811


1,608


57
%

11,941


7,299


4,642


64
%
General and administrative

3,477


2,443


1,034


42
%

10,578


5,252


5,326


101
%
Amortization of acquired intangible assets

409


409




%

1,227


1,227




%
Total operating expenses