S-1
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As filed with the Securities and Exchange Commission on June 10, 2014.

Registration No. 333-                

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

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 W. Scenic Pointe Dr.

Ste. 100

Draper, Utah 84020

(877) 694-3942

(Address, including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Offices)

 

 

Jon Kessler

President and Chief Executive Officer

15 W. Scenic Pointe Dr.

Ste. 100

Draper, Utah 84020

(877) 694-3942

(Name, Address, including Zip Code, and Telephone Number, including Area Code, of Agent for Service)

 

 

Copies to:

 

Gordon R. Caplan, Esq.

Morgan D. Elwyn, Esq.

Willkie Farr & Gallagher LLP

787 Seventh Avenue

New York, New York 10019

(212) 728-8000

 

Charles S. Kim, Esq.

Andrew S. Williamson, Esq.

David G. Peinsipp, Esq.

Cooley LLP

4401 Eastgate Mall

San Diego, California 92121

(858) 550-6000

 

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date hereof.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  ¨

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

  x  (Do not  check if a smaller reporting company)    Smaller reporting company   ¨

 

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to Be Registered

 

Proposed Maximum

Aggregate

Offering Price(1)(2)

 

Amount of

Registration Fee(3)

Common Stock, $0.0001 par value per share

  $100,000,000   $12,880

 

 

 

(1)   Includes offering price of shares which the underwriters have the option to purchase.

 

(2)   Estimated solely for the purpose of calculating the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

 

(3)   Calculated pursuant to Rule 457(o) based on an estimate of the proposed maximum aggregate offering price.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state or jurisdiction where the offer or sale is not permitted.

 

Subject to completion, dated                 , 2014

Prospectus

                shares

 

LOGO

Common stock

This is the initial public offering of shares of common stock of HealthEquity, Inc. We are offering                 shares of our common stock to be sold in the offering.

Prior to this offering, there has been no public market for our shares of common stock. The initial public offering price of our common stock is expected to be between $         and $         per share.

We have applied to list our common stock on the NASDAQ Global Select Market under the symbol “HQY”.

We are an “emerging growth company” as that term is used in the Jumpstart Our Business Startups Act of 2012 and, as such, have elected to comply with certain reduced public company reporting requirements for this prospectus and future filings.

 

      Per share      Total  

 

 

Initial public offering price

   $                    $                

Underwriting discounts and commissions(1)

   $                    $                

Proceeds to HealthEquity, Inc., before expenses

   $                    $                

 

(1)   See “Underwriting” for a description of the compensation payable to the underwriters.

We have granted the underwriters an option for a period of 30 days to purchase up to an additional                 shares of common stock at the initial public offering price, less the underwriting discounts and commissions, to cover over-allotments of shares, if any.

Investing in our common stock involves risks. See “Risk factors” beginning on page 18 of this prospectus.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares of common stock to purchasers on or about                , 2014.

 

J.P. Morgan   Wells Fargo Securities
Raymond James   Baird   SunTrust Robinson Humphrey

                , 2014


Table of Contents

Table of contents

 

     Page  

Prospectus summary

     1   

Risk factors

     18   

Special note regarding forward-looking statements and industry data

     44   

Use of proceeds

     46   

Dividend policy

     48   

Capitalization

     49   

Dilution

     52   

Selected consolidated financial and other data

     55   

Management’s discussion and analysis of financial condition and results of operations

     58   

Business

     87   

Management

     108   

Executive compensation

     114   

Director remuneration

     128   

Certain relationships and related party transactions

     130   

Principal stockholders

     134   

Description of capital stock

     137   

Shares eligible for future sale

     143   

Material U.S. federal income tax and estate tax consequences to non-U.S. holders

     145   

Underwriting

     150   

Legal matters

     155   

Experts

     155   

Change in independent accountant

     155   

Where you can find additional information

     156   

 

 

We have not, and the underwriters have not, authorized anyone to provide you with additional or different information other than that contained in this prospectus or in any free writing prospectus prepared by or on our behalf or to which we have referred you. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give to you. We are offering to sell shares of our common stock, and seeking offers to buy shares of our common stock, only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of our common stock. The information in this prospectus or any free writing prospectus is accurate only as of the date of this prospectus or such free writing prospectus, as applicable. Our business, financial condition, results of operations and prospects may have changed since that date.

Through and including                 , 2014 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.


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For investors outside the United States: Neither we nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about and to observe any restrictions relating to this offering and the distribution of this prospectus outside of the United States.


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Prospectus summary

The following summary highlights information contained elsewhere in this prospectus and does not contain all of the information that you should consider before investing in our common stock. You should read this entire prospectus, including the sections entitled “Risk factors,” “Management’s discussion and analysis of financial condition and results of operations” and our consolidated financial statements and the related notes to those statements before making an investment decision. Unless the context otherwise indicates or requires, the terms “we,” “our,” “us,” “HealthEquity,” and the “Company,” as used in this prospectus, refer to HealthEquity, Inc. and its subsidiaries as a combined entity, except where otherwise stated or where it is clear that the terms mean only HealthEquity, Inc. exclusive of its subsidiaries.

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. We can integrate with any health plan or banking institution to be the independent and trusted partner that enables consumers as they seek to manage, save and spend their healthcare dollars. We believe the secular shift to greater consumer responsibility for healthcare costs will require a significant portion of the approximately 175 million under-age 65 consumers with private health insurance in the United States to use a platform such as ours.

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. Our customers include individuals, employers of all sizes and health plans. We refer to our individual customers as our members, 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. Through our existing 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. As of May 2014, we have over 1.0 million HSAs on our platform, which we refer to as our HSA Members, representing over 2.3 million lives. During the years ended January 31, 2014 and 2013, we added approximately 306,000 and 216,000 new HSA Members, representing approximately 700,000 and 500,000 lives, respectively.

We developed technology and a differentiated focus on the consumer to facilitate the transition to a more consumer-centric approach to healthcare saving and spending. In an environment where consumers own greater responsibility for cost, they require better information, a more integrated experience, a customer service model that is similar to other consumer businesses, and the ability to make their dollars and data portable. By integrating healthcare saving and

 

 

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spending with the broader healthcare system, we are breaking down the wall between personal finance and healthcare and enabling consumers to make the transition to a consumer-centric healthcare environment. We do this in a number of key ways:

 

 

We connect people to their health and wealth data, delivering answers to critical consumer questions such as: What do I owe? What am I being billed for? How can I spend less? Did I get my health plan discount? Where should I invest my healthcare dollars?

 

 

We create a singular consumer healthcare ecosystem by allowing third-party applications, such as price transparency, telemedicine, and wellness tools, to plug into our platform to drive adoption among our members.

 

 

We deliver millions of personal and relevant messages, empowering consumers at critical healthcare “save” and “spend” moments.

 

 

We give consumers the freedom to move through the healthcare system by liberating their healthcare data and dollars.

We are a pioneer in the development of technology solutions that empower consumers to make informed healthcare saving and spending decisions. Our position as an innovator is demonstrated by a series of transformative accomplishments, which we believe to be industry-firsts, including:

 

  •  2003:   Offered 24/7/365 live support from health saving and spending experts;
  •  2004:   Published The Complete HSA Guidebook, a comprehensive reference now in its seventh edition;
  •  2005:   Integrated an HSA into a health plan;
  •  2006:   Authorized to act as an HSA custodian by the U.S. Department of the Treasury;
  •  2008:   Integrated claims-driven price transparency tools;
  •  2009:   Integrated HSAs with multiple health plans of a single large employer;
  •  2009:   Delivered integrated wellness incentives through an HSA;
  •  2009:   Partnered with a private health insurance exchange as its preferred HSA partner;
  •  2010:   Integrated enrollment on a state health insurance exchange;
  •  2011:   Integrated HSAs, HRAs, FSAs and investment accounts on one website; and
  •  2013:   Delivered HSA-specific online investment advice.

By prioritizing the consumer experience, we have been rewarded with consumer loyalty scores that far exceed those of most banks and traditional health insurers. While the number of consumers nationally with HSAs has grown annually by less than 30% over the past two calendar years, we have grown our HSAs at a 42% compounded annual growth rate over the past two fiscal years, significantly increasing our market share.

We believe the shift to healthcare consumerism is just beginning. The number of HSAs has grown from 4.9 million in December 2009 to 10.7 million in December 2013. From January 2009 to January 2013, the number of people in high deductible health plans, or HDHPs, that are eligible to be coupled with HSAs, which we refer to as HSA Plans, grew from 8.0 million to 15.5 million. Despite this growth, as of January 2013, the market remains significantly under-penetrated as this implies only approximately 9% penetration of the approximately 175 million individuals that constitute the under-age 65 U.S. private health insurance market.

 

 

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According to Consumer Driven Market Report, or CDMR, the number of people with HSAs is expected to reach 50 million by 2020. We believe this HSA growth will be driven, in part, by the Patient Protection and Affordable Care Act of 2010, or the PPACA, which requires nearly all legal U.S. residents to obtain health insurance with minimum essential coverage, commonly referred to as the “individual mandate,” or be subject to a tax penalty. We believe the individual mandate will drive consumers to HSA Plans, thus increasing the number of HSAs, because HSA Plans, with their low annual premiums, offer an affordable means of obtaining the health insurance coverage required by the individual mandate. We also believe medical cost inflation and higher income tax rates will drive HSA growth as consumers seek alternative ways to reduce their healthcare costs and tax expenses.

Our solution is deployed as a cloud-based platform that is accessible to our customers through the Internet and on mobile devices. We host our solution on private servers, which allows us to scale on demand. Core to our technology is a configurable framework and open platform that we believe provides us greater functionality and flexibility than generic technologies used by our legacy competitors and requires less investment and time to configure and customize to our customers’ needs. Our ability to seamlessly integrate third-party applications has also afforded us an advantage in an expanding consumer healthcare landscape.

Our business model provides strong visibility into our future operating performance. As of the beginning of the past several fiscal years, we have approximately 90% visibility into the revenue of the subsequent fiscal year. We charge monthly administration fees, primarily through multi-year contracts with our Network Partners, employer clients and individual members. We earn custodial fees, which are primarily interest earned on our cash assets under management, or AUM, deposited with our FDIC-insured custodial depository bank partners, fees earned by us from mutual funds in which our members invest on a self-directed basis, and fees for investment advisory services. We also earn card fees, which are primarily interchange fees charged to merchants on payments made with our cards via payment networks. Monthly account fees, custodial fees, and card fees are recurring in nature, providing strong visibility into our future business.

Because of our scalable technology platform and large number of existing Network Partners, our operating model provides a significant embedded organic growth opportunity and high returns on each incremental dollar of revenue. Over the past two years, our operating model has allowed us to:

 

 

grow the number of our HSA Members by 101%, with 81% coming from existing Network Partners;

 

increase our AUM by 96%;

 

reduce acquisition cost per HSA Member by 35%;

 

decrease our account cost per HSA Member by 19%; and

 

decrease our operating expense per HSA Member by 26%.

As a result, our total revenue increased from $46.1 million for the year ended January 31, 2013, to $62.0 million for the year ended January 31, 2014, representing growth of 35%, and our non-GAAP Adjusted EBITDA increased from $10.5 million for the year ended January 31, 2013, to $15.8 million for the year ended January 31, 2014, representing growth of 50%. Total revenue increased from $14.6 million for the unaudited three months ended April 30, 2013, to $20.2 million for the unaudited three months ended April 30, 2014, representing growth of 38%, and

 

 

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our non-GAAP Adjusted EBITDA increased from $3.8 million for the unaudited three months ended April 30, 2013, to $6.8 million for the unaudited three months ended April 30, 2014, representing growth of 77%. See “Selected consolidated financial and other data—Non-GAAP financial measures” for more information as to how we define and calculate Adjusted EBITDA and for a reconciliation of net income, the most comparable GAAP measure, to Adjusted EBITDA.

Our opportunity

We believe that the secular shift to greater consumer responsibility for healthcare costs has created a significant opportunity to offer a technology platform that transforms the way consumers engage with healthcare benefits and make healthcare saving and spending decisions. By combining innovations in technology, analytics, consumer experience and financial planning, we believe we are well-positioned to take advantage of the emergence of the new healthcare consumer.

We are addressing the large and growing U.S. health insurance market.    The U.S. under-age 65 private health insurance market consists of approximately 175 million people. The PPACA is widely expected to expand coverage among the 47 million uninsured Americans through its individual and employer mandates, premium subsidies, state health insurance exchanges and ban on withholding coverage due to pre-existing medical conditions. We further see an opportunity to address the 51 million Medicare-eligible Americans and have been involved in industry-wide efforts to expand HSA eligibility to this large and growing population. To date, we have penetrated less than 5% of our existing Network Partners who cover approximately 30% of the under-age 65 private health insurance market.

Health insurance is in the midst of major structural change.    Despite multiple efforts by employers, health plans and government, health insurance premium increases have exceeded worker-earnings increases and inflation in every year since 1998. Premiums have nearly tripled in that time, while worker earnings have increased 54%. In response, employers and health plans are increasingly adopting health insurance plans in which consumers own more financial responsibility through higher deductibles, increasingly utilizing HSA Plans. We believe the secular shift to greater consumer responsibility will require a shift to a health insurance model that approaches patients as consumers. We believe we enable this disruption of the traditional health insurance model by creating incentivized, engaged and empowered healthcare consumers.

HSAs and HSA assets are rapidly growing.    HSAs have grown from 4.9 million in 2009 to 10.7 million in 2013. HSA assets, comprised of both cash deposits and investments, have grown from $7.2 billion to $19.3 billion during this timeframe. Fewer than 3% of HSAs have investments today. However, as the structural shift in health insurance continues, we believe that health savings will become an important part of the consumer’s financial portfolio and planning, resulting in significant asset growth. The vintage of accounts continues to grow as well, naturally driving up assets.

PPACA implementation accelerates structural change.    As the PPACA is fully implemented, HSA growth will benefit from a significant expansion of the addressable market. We believe the PPACA’s individual mandate will drive consumers to purchase affordable insurance. Furthermore, according to a 2013 survey for Prudential Insurance by MRops, Inc. and Oxygen Research Inc., 49% of employers are extremely or very likely to eventually offer only HDHPs. State health exchanges, and the expected emergence of private exchanges, should also drive growth of HSAs.

 

 

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To meet consumer demand for lower premiums, a survey by HealthPocket Inc. found that insurance policies offered on seven state health exchanges had 26% higher deductibles on average than plans offered outside of the exchanges in 2013.

Patients are becoming engaged consumers.    The shift of financial responsibility drives consumers to take cost-conscious actions that result in permanent reduction in healthcare cost-trends. According to a 2013 Employee Benefit Research Institute, or EBRI, survey, individuals in HSA Plans and similar plans are more likely to exhibit the following behaviors than individuals in traditional plans:

 

 

57% confirm their plan would cover care ® 46% more likely to do so than those in traditional plans.

 

50% ask for a generic drug ® 35% more likely to do so than those in traditional plans.

 

40% talk with a doctor about drug costs ® 43% more likely to do so than those in traditional plans.

 

39% check cost before getting care ® 50% more likely to do so than those in traditional plans.

 

36% talk with a doctor about treatment costs ® 38% more likely to do so than those in traditional plans.

 

25% track healthcare spending online ® two times more likely to do so than those in traditional plans.

We believe that the greatest challenge health plans and employers face with consumer-centric health plans is the complexity these plans create for individual consumers. Offering consumers a secure, content-rich environment to make highly personal healthcare saving and spending decisions, one that brings together disparate data and provides data-driven individualized advice, is critical to empowering consumers to manage a greater portion of their healthcare cost responsibility.

Each HSA becomes a consumer ecosystem rather than a single product.    The shift of first-dollar responsibility for healthcare costs inherent in HSA Plans, sometimes called the “retail effect,” is giving rise to new consumer-centric solutions such as price transparency, retail clinics, telemedicine, and health and wealth financial planning. These solutions are all attempting to benefit from the growing reality that the consumer owns more of the healthcare financial burden. While many of these products and services have the potential to reduce costs, they are difficult to implement effectively without accessing the consumer at the critical “save” and “spend” moment. The HSA platform is becoming a natural hub for these solutions to integrate into the consumer experience because it is the place where consumers execute their healthcare saving and spending decisions and it is the point of integration for disparate patient-level clinical and administrative information. We believe that the ability of technology-enabled HSA platforms such as ours to integrate these disparate solutions into a singular experience for the healthcare consumer has the opportunity to transform the consumer experience and impact the adoption of this growing universe of new consumer-centric healthcare solutions.

Legacy competitors are not prepared to meet the growing needs of the healthcare consumer.    When HSAs came into being a decade ago, banks and transaction processors took early market share based on their transaction processing skills and commercial banking relationships with health insurers and employers. As the role of HSA platforms began to expand to become a critical component of the broader consumer healthcare experience, we believe that

 

 

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these and other firms recognized that solely applying legacy transaction processing capability to HSAs was not sufficient. Many of these legacy competitors such as Ceridian HCM, Inc., Citigroup Inc., Fidelity National Information Services (FIS), and JPMorgan Chase & Co. have either outsourced their HSA platform, exited the market, or announced plans to exit the market. Today, insurers and employers are turning to open technology-based firms such as ours that deliver a complete consumer experience by integrating HSAs with other consumer tools. We expect the growing complexity of the healthcare system and the emergence of more consumer-centric healthcare solutions will further increase the need for more complete healthcare-specific platforms such as ours.

Our competitive strengths

We believe we are well-positioned to benefit from the transformation of the healthcare benefits market. Our platform is aligned with a new healthcare environment that rewards consumer engagement and fosters an integrated consumer experience.

Leadership and first-mover advantage

We are a pioneer in the development of technology solutions that empower consumers to make informed healthcare saving and spending decisions. We have established a defensible leadership position in the HSA industry through our first-mover advantage, focus on innovation and differentiated capabilities. Our leadership position has been recognized by CDMR (2013), and is further evidenced by the doubling of our market share, from 4% in December 2010 to over 8% in January 2014, as noted by the 2013 Devenir HSA Research Report.

Our position as an innovator is demonstrated by a series of transformative accomplishments, which we believe to be industry-firsts, including:

 

 

2005:    Integrated an HSA into a health plan;

 

2006:    Authorized to act as an HSA custodian by the U.S. Department of the Treasury;

 

2008:    Integrated claims-driven price transparency tools;

 

2009:    Integrated HSAs with multiple health plans of a single large employer; and

 

2013:     Delivered HSA-specific online investment advice.

In 2012, we were named the fastest growing HSA provider over the last three years by CDMR. We believe our ability to secure a large portion of the health plan segment and many of the most innovative employers as Network Partners provides us a significant competitive advantage in a fast-growing market.

Complete solution for managing consumer healthcare saving and spending

We simplify the consumer’s healthcare decision-making process by leveraging our expertise and technology to create a single place for consumers to manage their healthcare saving and spending decisions. Our platform is positioned at the center of an emerging healthcare saving and spending ecosystem: a place where consumers can pay healthcare bills, compare treatment options and prices, receive personalized benefit and clinical information, earn wellness incentives, and make educated investment choices. During the year ended January 31, 2014, our platform experienced 7.9 million logons and, on average, every month 28% of our members signed into our platform and 13% reached out to one of our Member Education Specialists.

 

 

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A growing number of companies are attempting to integrate into the consumer’s daily healthcare spending experience by leveraging our platform. These companies, which offer functions such as price transparency, benefits enrollment, population health, wellness, analytics, health insurance, and investment services, are looking to reach the consumer at the critical “save” and “spend” moment.

Proprietary and integrated technology platform

We have a proprietary cloud-based technology platform, developed and refined during more than a decade of operations, which we believe is highly differentiated in the marketplace.

Purpose built technology:    Our platform was designed specifically to serve the needs of healthcare consumers, health plans and employers. We believe it provides greater functionality and flexibility than the generic technologies used by our competitors, many of which were originally developed for banking, benefits administration or retirement services. We believe we have the only platform that encompasses all of the core functionality of healthcare saving and spending in a single secure and compliant system.

Data integration:    Our technology platform allows us to integrate data from disparate sources, which enables us to seamlessly incorporate personal health information, clinical insight and individually tailored strategies into the consumer experience. We currently have more than 515 distinct integrations with health plans, pharmacy benefit managers, employers and other benefits provider systems, which we believe is more than any of our competitors.

Configurability:    Our technology platform enables us to create a unique solution for each of our Network Partners. A non-technical HealthEquity team member can configure up to 225 product attributes, including integration with a partner’s chosen healthcare price transparency or wellness tools, single sign on, sales and broker support site, branding, member communication, custom fulfillment and payment card, savings options and interest rates, fees and mutual fund investment choices. We currently have more than 715 unique partner configurations of our offerings in use.

Differentiated consumer experience

We have designed our solutions and support services to deliver a differentiated consumer experience, which is a function of our culture and technology. We believe this provides a significant competitive advantage relative to legacy competitors who we believe prioritize transaction processing and benefits administration.

Culture:    We call our culture “Purple,” which we define as our commitment to exceeding our customers’ expectations in a truly remarkable way. For example, since 2003, our health saving and spending experts have served our members live 24/7/365. This is because our members’ most important healthcare decisions are often made outside of business hours. During the year ended January 31, 2014, 26% of member calls happened at night, on weekends or on holidays.

Technology:    Our technology helps us to deliver on our commitment to being Purple. We tailor the content of our platform and the advice of our experts to be timely, personal and relevant to each member. For example, our technology generates health savings strategies that are delivered

 

 

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to our members when they interact with our platform or call us. We refer to these individualized education opportunities as Teachable Moments.

Our commitment to Purple has been rewarded with consumer loyalty scores that far exceed those of most banks and traditional health insurers. In addition, approximately 93% of all HSAs opened with us remain open as of April 30, 2014.

Large and diversified channel access

We believe our differentiated distribution platform provides a competitive advantage by efficiently enabling us to reach a consumer market that is projected to include 50 million people by 2020. Our platform is built on a business-to-business-to-consumer, or B2B2C, channel strategy whereby we rely on our Network Partners to reach consumers instead of marketing our services to these potential members directly.

Our Network Partners enable us to reach over 55 million consumer lives, representing 30% of the insured commercial lives in the United States.

Scalable operating model

We believe we have an attractive operating model due to the scalability of our solutions, the embedded growth opportunity within our existing customer base, the recurring nature of our revenue and the long-term low capital intensity and high free cash flow conversion of our business:

 

 

Our products and services are accessed primarily through our technology platform, which is cloud based. We believe that our technology is highly scalable. After initial on-boarding and a period of education, our account costs for any given customer typically decline over time.

 

 

Our opportunity to generate high-margin revenue from existing HSA Members grows over time because our HSA Members’ balances typically grow, increasing custodial fees at very little incremental cost to us. An account opened in any given fiscal year will have an average cash balance of approximately $750 at the end of that fiscal year, doubling to approximately $1,500 after two more years and tripling to approximately $2,250 after another three years. Further, our contribution margin per account on average rises from 57% at the end of the first fiscal year, to 67% at the end of the third fiscal year, to 71% by the end of the sixth fiscal year.

 

 

HSA Members from existing Network Partners typically have lower customer acquisition costs than those from other sources. From the year ended January 31, 2013 to the year ended January 31, 2014, our sales and marketing expenses dropped from 17% to 14% of revenue, and from the unaudited three months ended April 30, 2013 to the unaudited three months ended April 30, 2014, our sales and marketing expenses dropped from 12% to 11% of revenue. Since the beginning of the year ended January 31, 2013, the number of our HSA Members has more than doubled.

 

 

Retention of our HSA Members has been consistent over time. Approximately 93% of all HSAs opened on our platform remain open as of April 30, 2014.

We believe that a normalization of market interest rates would further increase our operating leverage as higher interest yields on cash AUM would generate custodial fees at little incremental cost to us.

 

 

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Our growth strategy

Our business model is defined by embedded growth from existing HSA Members and Network Partners, operating leverage and highly visible new revenue opportunities, giving us multiple avenues for long-term growth.

Penetrate the large membership opportunity within our existing network

We generate recurring account fees, paid by health plans, employers or individuals, based on the number of our HSA Members. We estimate that we have penetrated less than 5% of our existing Health Plan Partners and 12% of our existing Employer Partners with HSAs. 28 of our 57 Health Plan Partners were added in the past two fiscal years.

We expect our Health Plan Partners to eventually expand their coverage footprint as the uninsured begin purchasing coverage through state health insurance exchanges under the PPACA. As of May 31, 2014, nearly all of our Health Plan Partners participate in state health exchanges. 59 of the 62 Blue Cross and Blue Shield health plans nationwide participate overall.

Expand our network of Health Plan Partners and Employer Partners

We believe we are well-positioned to expand our network of Health Plan Partners and Employer Partners due to our growing market leadership, consistent innovation, open technology, and focus on the consumer experience. Our recent history is supportive of our ability to do this. Our market share has doubled, from 4% in December 2010 to over 8% in January 2014.

Increase our yield

The nature of our operating model drives significant incremental profitability from existing HSA Members’ AUM. We define this as increasing our yield. Opportunities to increase our yield include rising account balances, rising interest rates, and long-term investing.

Grow payment volume

As the dollar volume of transactions processed through our platform grows, we generate more revenue with little incremental cost. Driving these additional charges to our payment cards would increase transaction revenues.

Demonstrate operating leverage

We expect to drive increasing profitability from adding accounts through our existing network of Health Plan Partners and Employer Partners and servicing a larger number of mature accounts on our scalable platform. Our business model allows us to inexpensively add HSA Members through our existing Network Partners.

Capitalize on the new opportunity in health insurance exchanges

We are well-positioned to address the additional opportunity created by both state and private health insurance exchanges.

 

 

Our solutions are already integrated with partner health plan offerings in several state health exchanges.

 

 

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With regard to private exchanges, our solutions are already integrated with select partner health plans and exchange operators themselves.

 

 

Finally, state and private exchanges are widely expected to spur the growth of new major medical health plans, including from hospital-centered Accountable Care Organizations and state health “CO-OP” insurers capitalized through the PPACA.

Grow the HSA ecosystem

Our proven ability to innovate, large and growing HSA Member and Network Partner footprint, and high level of member engagement on our open technology platform together create a significant opportunity to expand our HSA ecosystem. We expect more third-party consumer solutions that want to be part of consumers’ daily healthcare decision-making to leverage our platform to reach our members at relevant decision points. We also have the opportunity to internally develop solutions and offer these to our customers.

Selectively pursue strategic acquisitions

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.

Risks related to our business

Investing in our common stock involves substantial risk. The risks described under the heading “Risk factors” immediately following this summary may cause us to not realize the full benefits of our strengths or may cause us to be unable to successfully execute all or part of our strategy. Some of the more significant challenges include the following:

 

 

the healthcare industry is rapidly evolving, and we may not be successful in promoting the benefits of our platform in the changing environment;

 

 

the market for technology-enabled services that empower healthcare consumers is relatively immature and unproven and it is uncertain whether this market will achieve and sustain high levels of demand and market adoption;

 

 

we may face breaches of security measures and unauthorized access to or disclosure of data relating to our customers, which could harm our reputation and cause us to incur significant liabilities and lose customers;

 

 

we face substantial and increasing competition in our business from a number of competitors, many of which have substantially greater resources than we do;

 

 

developments in the healthcare industry and related changes in applicable federal and state laws, including any diminution in, elimination of, or change in the availability of tax-advantaged healthcare accounts such as HSAs, could reduce our revenue or adversely affect our profitability;

 

 

we operate in a highly regulated environment; failure to comply with applicable laws or regulations, or changes in those laws or regulations that adversely affect our operating methods, could negatively impact our business;

 

 

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our principal stockholder, Berkley Capital Investors, L.P., or Berkley, will beneficially own approximately                 % of our outstanding common stock following this offering (or                 % if the underwriters’ over-allotment option is exercised in full) thereby allowing Berkley to influence our management and affairs and matters requiring stockholder approval through its ownership position;

 

 

our quarterly results may fluctuate significantly;

 

 

if we fail to manage our rapid growth effectively, our expenses could increase more than expected, our revenue could decrease and we may be unable to implement our business strategy;

 

 

we outsource critical operations, including certain banking services, which exposes us to risks related to our third-party vendors; and

 

 

we depend on a strong brand and a failure to maintain and develop our brand in a cost-effective manner may hurt our ability to expand our customer base.

You should carefully consider all of the information included in this prospectus, including matters set forth under the headings “Risk factors” and “Special note regarding forward-looking statements and industry data,” before deciding to invest in our common stock.

Corporate history and other information

HealthEquity, Inc. was incorporated as a Delaware corporation on September 18, 2002. Our principal business office is located at 15 W. Scenic Pointe Dr., Ste. 100, Draper, Utah 84020. Our website address is www.healthequity.com. We do not incorporate the information contained on, or accessible through, our corporate website into this prospectus, and you should not consider it to be part of this prospectus.

Upon completion of this offering, Berkley will beneficially own             % of our outstanding common stock (or             % if the underwriters’ over-allotment option is exercised in full). Berkley has been an investor in our company since October 2006, when it acquired approximately 5.2 million shares of our series C redeemable convertible preferred stock. In October 2008 and December 2008, Berkley acquired shares of our series D-1 redeemable convertible preferred stock and series D-2 redeemable convertible preferred stock, respectively, and, in each of August 2011, January 2012 and January 2013, Berkley acquired shares of our series D-3 redeemable convertible preferred stock. Frank T. Medici and Thomas H. Ghegan, both members of our board of directors, are officers of Berkley Capital, LLC, the general partner of Berkley, and share sole voting and dispositive power over the shares held by Berkley. See “Principal Stockholders.”

“HealthEquity” and “Building Health Savings” are our trademarks. All other trademarks, service marks and trade names appearing in this prospectus are the property of their respective owners. Solely for convenience, the trademarks and trade names in this prospectus are referred to without the ® and ™ symbols, but such references should not be construed as any indicator that their respective owners will not assert, to the fullest extent under applicable law, their rights thereto. Use or display by us of other parties’ trademarks, trade names or service marks is not intended to and does not imply a relationship with, or endorsement or sponsorship by us of, the trademark, trade name or service mark owner.

 

 

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Implications of being an emerging growth company

We qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. As an emerging growth company, we have elected to take advantage of the reduced disclosure requirements available to emerging growth companies under the JOBS Act about our executive compensation arrangements and the presentation of audited and selected financial data and an exemption from the auditor attestation requirement in the assessment of our internal controls over financial reporting pursuant to the Sarbanes-Oxley Act of 2002.

As a result of these elections, the information that we provide in this prospectus may be different than the information you may receive from other public companies in which you hold equity interests. In addition, it is possible that some investors will find our common stock less attractive as a result of our elections, which may result in a less active trading market for our shares and more volatility in our stock price.

We may take advantage of these provisions until we are no longer an emerging growth company. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of the completion of this offering, (b) in which we have total annual gross revenue of at least $1.0 billion or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the prior July 31st, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

In addition, Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, or the Securities Act, for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we are choosing to opt out of such extended transition period, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

 

 

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The offering

 

Common stock offered by us

                shares

 

Total common stock offered

                shares (or                 shares if the underwriters exercise in full their option to purchase additional shares)

 

Over-allotment option

The underwriters have a 30-day option to purchase up to an additional                 shares of our common stock from us.

 

Use of proceeds

We intend to use the net proceeds from this offering (i) to pay a previously declared cash dividend of approximately $         on shares of our common stock, convertible preferred stock, and redeemable convertible preferred stock outstanding on the day immediately prior to the closing date of this offering, (ii) to pay a cash dividend of approximately $         on shares of our outstanding series D-3 redeemable convertible preferred stock accrued through the date of conversion of such shares into common stock, which will occur on the closing date of this offering, and (iii) for general corporate purposes, including the costs associated with being a public company. See “Use of proceeds.”

 

Risk factors

See “Risk factors” for a discussion of factors you should carefully consider before deciding whether to invest in our common stock.

 

Dividend policy

Our board of directors declared a cash dividend in an aggregate amount of approximately $         , which is payable on shares of our common stock, convertible preferred stock, and redeemable convertible preferred stock outstanding on the day immediately prior to the closing date of this offering. In addition, an aggregate amount of $         is payable on shares of our outstanding series D-3 redeemable convertible preferred stock accrued through the date of conversion of such shares into common stock, which will occur on the closing date of this offering. The dividends will be paid from the net proceeds of this offering and will not be paid on any shares purchased in this offering. We do not otherwise pay cash dividends on our common stock and do not anticipate paying any dividends on our common stock in the foreseeable future. Any future determinations relating to our dividend policies will be made at the discretion of our board of directors and will depend on various factors. See “Dividend policy.”

 

Proposed NASDAQ symbol

“HQY.”

 

 

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The number of shares of our common stock to be outstanding after this offering is based on 40,472,756 shares of our common stock outstanding as of May 31, 2014 and excludes:

 

 

5,799,550 shares of our common stock issuable upon the exercise of outstanding stock options as of May 31, 2014, at a weighted average exercise price of $1.81 per share, of which 3,128,850 options are exercisable as of such date;

 

 

2,571,324 shares of common stock issuable upon the exercise of outstanding warrants as of May 31, 2014 at a weighted average exercise price of $0.77 per share, certain of which outstanding warrants will be automatically cancelled upon the closing of this offering if not previously exercised; and

 

 

454,500 shares of our common stock reserved for future grant or issuance under our 2014 Equity Incentive Plan, which will be amended and restated in connection with the completion of this offering. See “Executive compensation—Additional incentive compensation plans and awards—2014 equity incentive plan.”

Unless we indicate otherwise, the information in this prospectus assumes:

 

 

the conversion of all of our outstanding convertible preferred stock and redeemable convertible preferred stock as of May 31, 2014 into an aggregate of 32,486,588 shares of common stock in connection with the closing of this offering;

 

 

no exercise by the underwriters of their over-allotment option;

 

 

that the initial public offering price of our shares of common stock will be $         per share (which is the midpoint of the estimated price range set forth on the cover page of this prospectus); and

 

 

the filing of our amended and restated certificate of incorporation and the adoption of our amended and restated bylaws immediately prior to the close of this offering.

 

 

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Summary consolidated financial and other data

The following tables summarize our consolidated statements of operations and comprehensive income and selected consolidated balance sheet data. The summary consolidated statements of operations and comprehensive income for the years ended January 31, 2014 and 2013 and the summary consolidated balance sheet data as of January 31, 2014 and 2013 have been derived from our audited consolidated financial statements and the notes thereto included elsewhere in this prospectus. The unaudited consolidated statement of operations and comprehensive income for the three months ended April 30, 2014 and 2013, as well as the unaudited consolidated balance sheet data as of April 30, 2014, are derived from our unaudited interim consolidated financial statements included elsewhere in this prospectus. The unaudited interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in our opinion, reflect all adjustments necessary for the fair presentation of the financial information set forth in those statements. Our historical operating results are not necessarily indicative of future operating results, and our interim results are not necessarily indicative of the results to be expected for the full year or any other period.

The following data should be read together with our consolidated financial statements and the related notes thereto, as well as the section entitled “Management’s discussion and analysis of financial condition and results of operations,” included elsewhere in this prospectus.

 

      Three months ended April 30,     Year ended January 31,  
(in thousands, except per share data)            2014                 2013             2014                 2013  
     (unaudited)     (unaudited)              

Consolidated Statements of Operations and Comprehensive Income Data:

        

Revenue

   $ 20,231      $ 14,624      $ 62,015      $ 46,088   

Cost of Services

     8,772        6,965        29,213        21,968   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross Profit

     11,459        7,659        32,802        24,120   

Operating Expenses

     5,971        4,733        21,278        17,028   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from Operations

     5,488        2,926        11,524        7,092   

Other Expense

     (827     (83     (6,150     (590
  

 

 

   

 

 

   

 

 

   

 

 

 

Income Before Income Taxes

     4,661        2,843        5,374        6,502   

Income Tax Provision (Benefit)

     1,943        1,093        4,141        (4,667
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income and Comprehensive Income

   $ 2,718      $ 1,750      $ 1,233      $ 11,169   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common stockholders:

        

Basic

   $ 3,849      $ 422      $ (7,132   $ 3,993   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 3,453      $ 1,497      $ (7,132   $ 9,562   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share attributable to common stockholders:

        

Basic

   $ 0.52      $ 0.08      $ (1.26   $ 0.81   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.08      $ 0.04      $ (1.26   $ 0.25   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

        

Basic

     7,367        5,491        5,651        4,924   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     43,736        37,612        5,651        37,514   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net income per share attributable to common stock holders (unaudited):

        

Basic

   $          $       
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $          $       
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

 

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      As of April 30, 2014  
     Actual      Pro forma(1)      Pro forma as
adjusted(2)
 
(in thousands)            (unaudited)      (unaudited)  

Consolidated Balance Sheet Data:

        

Cash and Cash Equivalents

   $ 13,990       $                            $                        

Working Capital(3)

   $ 17,806       $                            $                        

Total Assets

   $ 55,922       $                            $                        

Redeemable Convertible Preferred Stock

   $ 42,693       $                            $                        

Total Stockholders’ Equity

   $ 1,648       $                            $                        

 

 

 

(1)   The pro forma column assumes the effect of (i) our board of directors’ declaration of a cash dividend of $             on shares of our common stock, convertible preferred stock and redeemable convertible preferred stock outstanding on the day immediately prior to the closing date of this offering, and the payment thereof, (ii) the payment of a cash dividend of approximately $             on shares of our outstanding series D-3 redeemable convertible preferred stock accrued through the date of conversion of such shares into common stock, which will occur on the closing date of this offering, and (iii) the automatic conversion of our outstanding convertible preferred stock and redeemable convertible preferred stock into 32,486,588 shares of common stock prior to completion of this offering.

 

(2)   The pro forma as adjusted column gives effect to the transactions described in footnote 1 and the sale of                  shares of common stock in this offering by us, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, as if the events had occurred on April 30, 2014. A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) the net proceeds to us from this offering by $             million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

(3)   Working capital represents the excess of current assets over current liabilities as follows for the period indicated:

 

      Actual      Pro forma      Pro forma as
adjusted
 
              (unaudited)      (unaudited)  

Total current assets

   $ 23,647       $                            $                        

Total current liabilities

     5,841         
  

 

 

 

Working capital

   $ 17,806       $                $            

 

 

 

 

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Other data:

The following table represents the number of HSA Members as of April 30, 2014 and 2013, and as of January 31, 2014 and 2013, respectively. See “Management’s discussion and analysis of financial condition and results of operations—Key financial and operating metrics—HSA members” for more information as to how we define HSA Members.

 

      As of April 30,      As of January 31,  
     

2014

    

2013

     2014      2013  

HSA Members

     1,008,083         695,109         967,710         677,251   
  

 

 

    

 

 

    

 

 

 

Average HSA Members

     992,225         689,156         747,182         532,053   

 

    

 

 

    

 

 

 

The following table represents AUM as of April 30, 2014 and 2013, and as of January 31, 2014 and 2013, respectively. See “Management’s discussion and analysis of financial condition and results of operations—Key financial and operating metrics—Assets under management” for more information as to how we define AUM.

 

      As of April 30,      As of January 31,  
(in thousands)    2014      2013      $ Change      2014      2013      $ Change  

Cash AUM

   $ 1,488,543       $ 1,105,332       $ 383,211       $ 1,442,336       $ 1,060,696       $ 381,640   

Investment AUM

     212,041         120,741         91,300         182,614         103,335         79,279   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total AUM

   $ 1,700,584       $ 1,226,073       $ 474,511       $ 1,624,950       $ 1,164,031       $ 460,919   
  

 

 

    

 

 

    

 

 

    

 

 

 

Average Daily Cash AUM

   $ 1,459,478       $ 1,086,150       $ 373,328       $ 1,137,825       $ 829,427       $ 308,398   

 

    

 

 

    

 

 

    

 

 

 

The following table represents Adjusted EBITDA for the three months ended April 30, 2014 and 2013, and for the year-ended January 31, 2014 and 2013, respectively. See “Selected consolidated financial and other data—Non-GAAP financial measures“ for more information as to how we define and calculate Adjusted EBITDA and for a reconciliation of net income, the most comparable GAAP measure, to Adjusted EBITDA.

 

      Three months ended April 30,      Year ended January 31,  
(in thousands)            2014              2013     

        2014

    

        2013

 

Adjusted EBITDA

   $ 6,804       $ 3,838       $ 15,769       $ 10,504   

 

  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

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Risk factors

Investing in our common stock involves a high degree of risk. You should consider and read carefully all of the risks and uncertainties described below, as well as other information included in this prospectus, including our consolidated financial statements and related notes appearing at the end of this prospectus, before making an investment decision. The occurrence of any of the following risks could materially and adversely affect our business, financial condition or results of operations. In such case, the trading price of our common stock could decline, and you may lose all or part of your original investment. This prospectus also contains forward-looking statements and estimates that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of specific factors, including the risks and uncertainties described below.

Risks relating to our business and industry

The healthcare industry is rapidly evolving and the market for technology-enabled services that empower healthcare consumers is relatively immature and unproven. If we are not successful in promoting the benefits of our platform, our growth may be limited.

The market for our products and services is subject to rapid and significant changes. The market for technology-enabled services that empower healthcare consumers is characterized by rapid technological change, new product and service introductions, evolving industry standards, changing customer needs and the entrance of non-traditional competitors. In addition, there may be a limited-time opportunity to achieve and maintain a significant share of this market due in part to the rapidly evolving nature of the healthcare and technology industries and the substantial resources available to our existing and potential competitors. The market for technology-enabled services that empower healthcare consumers is relatively new and unproven, and it is uncertain whether this market will achieve and sustain high levels of demand and market adoption. In order to remain competitive, we are continually involved in a number of projects to develop new services or compete with these new market entrants, including the development of mobile versions of our proprietary technology platform and our introduction of investment advisory services. These projects carry risks, such as cost overruns, delays in delivery, performance problems and lack of acceptance by our customers.

Furthermore, based on our experience with our customers, we believe that many consumers are not familiar with the tax-advantaged benefits of HSAs and other similar tax-advantaged healthcare savings arrangements. Our success will depend to a substantial extent on the willingness of consumers to increase their use of technology platforms to manage their healthcare saving and spending, the ability of our platform to increase consumer engagement, and our ability to demonstrate the value of our platform to our existing customers and potential customers. If our existing customers do not recognize or acknowledge the benefits of our platform or our platform does not drive consumer engagement, then the market for our products and services might not develop at all, or it might develop more slowly than we expect, either of which could adversely affect our operating results. In addition, we have limited insight into trends that might develop and affect our business. We might make errors in predicting and reacting to relevant business, legal and regulatory trends, which could harm our business. If any of these events occur, it could materially adversely affect our business, financial condition or results of operations.

 

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Finally, our competitors may have the ability to devote more financial and operational resources than we can to developing new technologies and services, including services that provide improved operating functionality, and adding features to their existing service offerings. If successful, their development efforts could render our services less desirable, resulting in the loss of our existing customers or a reduction in the fees we generate from our products and services.

If our security measures are breached or unauthorized access to data is otherwise obtained, our platform may be perceived as not being secure, our customers may reduce the use of, or stop using, our products and services and we may incur significant liabilities.

Our proprietary technology platform enables the exchange of, and access to, sensitive information, and security breaches could result in the loss of this information, theft or loss of actual funds, litigation, indemnity obligations to our customers and other liabilities. While we have security measures in place, if our security measures are breached as a result of third-party action, employee error or otherwise, our reputation could be significantly damaged, our business may suffer and we could incur substantial liability. For example, we have in the past experienced security breaches which, although such breaches did not result in any claims against us, could be indicative of the potential for future security breaches. If third parties improperly obtain and use the personal information of our customers, we may be required to expend significant resources to resolve these problems. A major breach of our network security and systems could have serious negative consequences for our businesses, including:

 

 

possible fines, penalties and damages;

 

reduced demand for our services;

 

an unwillingness of consumers to provide us with their credit card or payment information;

 

an unwillingness of customers to provide us with personal information; and

 

harm to our reputation and brand.

Because techniques used to obtain unauthorized access to or sabotage systems change frequently and generally are not identified until they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any or all of these issues could negatively impact our ability to attract new customers and increase engagement by existing customers, and/or subject us to third-party lawsuits, regulatory fines, contractual liability and/or other action or liability, thereby harming our operating results.

Cybersecurity breaches could compromise our data and the data of our customers and partners, which may expose us to liability and would likely cause our business and reputation to suffer.

Our ability to ensure the security of our online platform and thus sensitive customer and partner information is critical to our operations. We rely on standard Internet and other security systems to provide the security and authentication necessary to effect secure transmission of data. Despite our security measures, our information technology and infrastructure may be vulnerable to cybersecurity threats, including attacks by hackers and other malfeasance. Any such security breach could compromise our networks and result in the information stored or transmitted there to be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings leading to liability, including under laws that protect the privacy of personal information, disrupt our operations and the services we provide to our clients, damage our reputation and cause a loss of confidence in our products and services, which could adversely affect our business, operations and competitive position.

 

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Fraudulent and other illegal activity involving our products and services, including our payment cards, could lead to reputational damage to us and reduce the use and acceptance of our platform.

Criminals are using increasingly sophisticated methods to capture personal account information in order to engage in illegal activities such as counterfeiting and identity theft. We rely upon third parties for some transaction processing services, which subjects us to risks related to the vulnerabilities of those third parties. For example, we were exposed to risks relating to the 2013 theft of payment card numbers housed in Target Corporation’s point of sale system when certain of our members used our payment cards at Target Corporation and those cards were compromised. Under our agreement with our payment card processing network, we are required to make our customers whole for losses sustained when using our payment cards, even in instances where we are not directly responsible for the underlying cause of such loss. A single significant incident of fraud, or increases in the overall level of fraud, involving our payment cards, our custodial accounts or our reimbursement administration services, could result in reputational damage to us, which could reduce the use and acceptance of our products and services, cause our customers to cease doing business with us or lead to greater regulation that would increase our compliance costs.

We may be unable to compete effectively against our current and future competitors.

The market for our products and services is highly competitive, rapidly evolving and fragmented. We view our competition in terms of direct and indirect competitors. Our direct competitors are HSA custodians that include state or federally chartered banks, such as Optum Bank, JPMorgan Chase & Co. and Webster Bank, N.A., and non-bank custodians approved by the U.S. Treasury as meeting certain ownership, capitalization, expertise and governance requirements, such as Payflex Systems USA, Inc. (Payflex). This market is highly fragmented and characterized by more than 2,200 HSA custodians. We also have numerous indirect competitors, including benefits administration technology and service providers that work with other HSA custodians to sell into health plans and/or employer channels.

Many of our competitors, in particular commercial banks and financial institutions, have longer operating histories and significantly greater financial, technical, marketing and other resources than we have. As a result, some of these competitors may be in a position to devote greater resources to the development, promotion, sale and support of their products and services and have offered, or may in the future offer, a wider range of products and services that may be more attractive to potential customers, and they may also use advertising and marketing strategies that achieve broader brand recognition or acceptance. For example, our competitors that are commercial banks and financial institutions may leverage their ability to generate revenue from other banking activities and decide to offer no-fee HSAs, which may permit them to increase market share in our market. Furthermore, if one or more of our competitors were to merge or partner with another of our competitors, the change in the competitive landscape could materially adversely affect our ability to compete effectively. Our competitors may also establish or strengthen cooperative relationships with our current or future Network Partners or other strategic partners, thereby limiting our ability to promote our solution with these parties.

In addition, well-known retail mutual fund companies, such as Fidelity and Vanguard, who currently do not have a strong presence or have somewhat limited products in the market for technology-enabled services that empower healthcare consumers may in the future decide to expand their products or attempt to grow their presence in the market. These investment

 

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companies have significant advantages over us in terms of brand name recognition, years of experience managing tax-advantaged retirement accounts (e.g., 401(k) and IRA), highly developed recordkeeping, trust functions, and fund advisory and customer relations management, among others. If we are unable to compete effectively with new competitors, our results of operations, financial condition, business and prospects could be materially adversely affected.

Developments in the healthcare industry could adversely affect our business.

Substantially all of our revenue is derived from healthcare-related saving and spending by consumers, which could be affected by changes affecting the broader healthcare industry, including decreased spending in the industry overall. General reductions in expenditures by healthcare industry participants could result from, among other things:

 

 

government regulation or private initiatives that affect the manner in which healthcare industry participants interact with consumers and the general public;

 

 

consolidation of healthcare industry participants;

 

 

reductions in governmental funding for healthcare; and

 

 

adverse changes in business or economic conditions affecting healthcare industry participants.

Even if general expenditures by industry participants remain the same or increase, developments in the healthcare industry may result in reduced spending in some or all of the specific market segments that we serve now or in the future. The healthcare industry has changed significantly in recent years, and we expect that significant changes will continue to occur. However, the timing and impact of developments in the healthcare industry are difficult to predict. We cannot assure you that the demand for our products and services will continue to exist at current levels or that we will have adequate technical, financial and marketing resources to react to changes in the healthcare industry.

The healthcare regulatory and political framework is uncertain and evolving.

Healthcare laws and regulations are rapidly evolving and may change significantly in the future, which could adversely affect our financial condition and results of operations. For example, in March 2010, President Barack Obama signed the PPACA, a health care reform measure which provides healthcare insurance for approximately 30 million more Americans. The PPACA includes a variety of healthcare reform provisions and requirements that will become effective at varying times through 2018, substantially changes the way health care is financed by both governmental and private insurers, and may significantly impact our industry. Many of the provisions of the PPACA will phase in over the course of the next several years, and we may be unable to predict accurately what effect the PPACA or other healthcare reform measures that may be adopted in the future will have on our business.

Changes in applicable federal and state laws relating to the tax benefits available through tax-advantaged healthcare accounts such as HSAs would materially adversely affect our business.

The efforts of governmental and third-party payers to raise revenue or contain or reduce the costs of healthcare may adversely affect our business, operating results, and financial condition. We expect that there will continue to be a number of legislative and regulatory proposals aimed at changing the U.S. healthcare system, which could include restructuring the tax benefits

 

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available through HSAs, FSAs and similar tax-advantaged healthcare accounts. For example, states may seek to raise revenues by enacting tax laws that eliminate the tax deductions available to individuals who contribute to HSAs. Our business is substantially dependent on the tax benefits available through HSAs. If the laws or regulations are changed to limit or eliminate the tax benefits available through these accounts, such a change would have a material adverse effect on our business.

We may be subject to criminal or civil sanctions if we fail to comply with privacy regulations regarding the access, use and disclosure of personally identifiable information, including the Health Insurance Portability and Accountability Act of 1996, or HIPAA.

Numerous state and federal laws and regulations govern the collection, dissemination, access and use of personally identifiable information, including HIPAA, which governs the treatment of protected health information, a specific type of personally identifiable information. In the provision of services to our customers, we and our third-party vendors may collect, access, use, maintain and transmit protected health information in ways that are subject to many of these laws and regulations.

HIPAA applies to covered entities (e.g., health plans, healthcare clearinghouses and most providers). HIPAA also applies to “business associates” of covered entities, which include individuals and entities that provide services for or on behalf of covered entities pursuant to which the service provider may access protected health information. We are a business associate to our Health Plan Partners and to those other covered entities to which we provide services that involve our receipt, access, and/or creation of protected health information. On January 17, 2013, the United States Department of Health and Human Services issued a final rule to implement modifications to HIPAA, such as business associate compliance, determination and reporting of security breaches, and penalties, as well as modifications as required in the Genetic Information Nondiscrimination Act of 2008. The final rule also revises the standard used to determine when entities are required to report security breaches and also makes covered entities liable for the acts of their business associates and business associates liable for the acts of their subcontractors, who are now also deemed business associates, in accordance with the federal common law of agency. If we or any of our subcontractors experience a breach of patient information, the expanded liability for business associates could result in substantial financial and reputational harm.

The two rules that were promulgated pursuant to HIPAA that could most significantly affect our business are: (i) the Standards for Privacy of Individually Identifiable Health Information, or the Privacy Rule, and (ii) the Security Standards for the Protection of Electronic Protected Health Information, or the Security Rule. The Privacy Rule restricts the use and disclosure of patient information, and requires entities to safeguard that information and to provide certain rights to individuals with respect to that information. The Security Rule establishes elaborate requirements for safeguarding patient health information transmitted or stored electronically. The Privacy Rule and the Security Rule require the development and implementation of detailed policies, procedures, contracts and forms to assure compliance. We have implemented such compliance measures, but we may be required to make additional costly system purchases and modifications to comply with evolving HIPAA rules and to perform periodic audits and refinements as required by HIPAA.

Other federal and state laws restricting the use and protecting the privacy and security of protected health information and/or personally identifiable information also apply to us directly

 

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by law or indirectly through contractual obligations to our members that are directly subject to the laws. If we do not properly comply with existing or new laws and regulations related to protected health information and personally identifiable information, we could be subject to criminal or civil sanctions.

We are subject to various privacy related regulations promulgated under the Gramm-Leach-Bliley Act, which may include increased cost of compliance.

We are subject to various laws, rules and regulations related to privacy, information security and data protection promulgated under the Gramm-Leach-Bliley Act, and we could be negatively impacted by these laws, rules and regulations. The Gramm-Leach-Bliley Act guidelines require, among other things, that we develop, implement and maintain a written, comprehensive information security program containing safeguards that are appropriate to our size and complexity, the nature and scope of our activities and the sensitivity of any customer information at issue. Our management believes that we are currently operating in compliance with these regulations. However, continued compliance with these laws, rules and regulations regarding the privacy, security and protection of our customers’ data, or the implementation of any additional privacy rules and regulations, could result in higher compliance and technology costs for us.

Changes in laws and regulations relating to interchange fees on payment card transactions would adversely affect our revenue and results of operations.

At both the federal and state level, there are recent changes and proposed changes to existing laws and regulations that would limit the fees or interchange rates that can be charged on payment card transactions. For example, the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act known as the Durbin Amendment gave the Federal Reserve Board, or the FRB, the power to regulate payment card interchange fees. On June 29, 2011, the FRB issued its final rule that set a cap, which took effect on October 1, 2011, on the interchange fee an issuer can receive from a single payment card transaction. Our HSA-linked payment cards are exempt from the rule. However, to the extent that our other payment cards or issuing banks lose their exempt status, the interchange rates applicable to transactions involving our payment cards or issuing banks could be impacted, which would decrease our revenue and profit and could have a material adverse effect on our financial condition and results of operations.

Our investment advisory services are subject to complex regulation, and any compliance failures or regulatory action could adversely affect our business.

Our subsidiary HealthEquity Advisors, LLC is a registered investment advisor that provides web-only investment advisory services. As such, it must comply with the requirements of the Investment Advisers Act of 1940, or the Advisers Act, and related U.S. Securities and Exchange Commission, or SEC, regulations. Such requirements relate to, among other things, disclosure obligations, recordkeeping and reporting requirements, marketing restrictions and general anti-fraud prohibitions. The SEC is authorized to institute proceedings and impose sanctions for violations of the Advisers Act, ranging from fines and censure to termination of an investment adviser’s registration. Investment advisers also are subject to certain state securities laws and regulations. Compliance with any new regulatory requirements may divert internal resources and take significant time and effort. Any claim of non-compliance, regardless of merit or ultimate outcome, could subject us to investigation by the SEC, or other regulatory authorities. This in turn could result in additional claims or class action litigation brought on behalf of our clients, any of which could result in substantial cost to us and divert management’s attention and other

 

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resources away from our operations. Furthermore, investor perceptions in us may suffer, and this could cause a decline in the market price of our common stock. Our compliance processes may not be sufficient to prevent assertions that we failed to comply with any applicable law, rule or regulation.

Our distribution model relies on the cooperation of our Network Partners. If our Network Partners choose to partner with other providers of technology-enabled services that empower healthcare consumers, including HSA services, our business could be materially and adversely affected.

Our business depends on our Network Partners’ willingness to partner with us to offer their customers and/or employees our products and services. Certain of our Health Plan Partners enjoy significant market share in various geographic regions. If these Health Plan Partners choose to partner with our competitors, our results of operations, business and prospects could be materially adversely affected.

Declining levels of interest rates may reduce our ability to generate income on our cash AUM and to attract deposits into HSAs, which would adversely affect our profitability.

As a non-bank custodian, we must partner with our FDIC-insured custodial depository bank partners to hold and invest our cash AUM. We generate a significant portion of our consolidated revenue from fees we earn from our FDIC-insured custodial depository bank partners. For example, during the unaudited three months ended April 30, 2014 and for the year ended January 31, 2014 we generated approximately 27% and 31%, respectively, of our total revenue from custodial fees. A decline in prevailing interest rates may negatively affect our business by reducing the yield we realize on our cash AUM. In addition, if we do not offer our HSA Members competitive interest rates, our members may choose not to deposit their HSA cash balances with us. Any such scenario could materially and adversely affect our business and results of operations.

If our customers do not continue to utilize our payment cards, our results of operations, business and prospects would be materially adversely affected.

We derived 21%, 21%, 19% and 18% of our total revenue during the unaudited three months ended April 30, 2014 and 2013, and the years ended January 31, 2014 and 2013, respectively, from fees that are paid to us when our customers utilize our payment cards. These fees represent a percentage of the expenses transacted on each card. If our customers do not use these payment cards at the rate we expect, if they elect to withdraw funds using a non-revenue generating mechanism such as direct reimbursement, or if other alternatives to these payment cards develop, our results of operations, business and prospects would be materially adversely affected.

We rely on a single bank identification number sponsor for our payment cards, and a change in relationship with this sponsor or its failure to comply with certain banking regulations could materially and adversely affect our business.

We rely on a single bank identification number sponsor, or BIN sponsor, in relation to the payment cards we issue. If any material adverse event were to affect our BIN sponsor, including a significant decline in its financial condition, a decline in the quality of its service, its inability to comply with applicable banking and financial service regulatory requirements, systems failure or its inability to pay us fees, our business, financial condition and results of operations could be materially and adversely affected. In addition, we do not have a long-term contract with our BIN sponsor, and it may increase the fees they charge us or terminate their relationship with us. If we were required to change BIN sponsors, we could not accurately predict the success of such change

 

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or that the terms of our agreement with a new BIN sponsor would be as favorable to us, especially in light of the recent increased regulatory scrutiny of the payment card industry, which has rendered the market for BIN sponsor services less competitive.

We rely on our FDIC-insured custodial depository bank partners for certain custodial account services from which we generate fees. A business failure in any FDIC-insured custodial depository bank partner would materially and adversely affect our business.

As a non-bank custodian, we rely on our seven FDIC-insured custodial bank partners to hold and invest our cash AUM. If any material adverse event were to affect one of our FDIC-insured custodial depository bank partners, including a significant decline in its financial condition, a decline in the quality of its service, loss of deposits, its inability to comply with applicable banking and financial services regulatory requirements, systems failure or its inability to pay us fees, our business, financial condition and results of operations could be materially and adversely affected. If we were required to change custodial depository banking partners, we could not accurately predict the success of such change or that the terms of our agreement with a new banking partner would be as favorable to us as our current agreements, especially in light of the recent consolidation in the banking industry, which has rendered the market for FDIC-insured retail banking services less competitive.

We receive important services from third-party vendors. Replacing them would be difficult and disruptive to our business.

We have entered into contracts with third-party vendors to provide critical services relating to our business, including fraud management and other customer verification services, transaction processing and settlement, and card production. For example, we rely on a third-party vendor to process transactions involving our payment cards. Accordingly, we depend, in part, on the services, technology and software of this vendor and other third-party service providers. In the event that these service providers fail to maintain adequate levels of support, do not provide high quality service, increase the fees they charge us, discontinue their lines of business, terminate our contractual arrangements or cease or reduce operations, we may suffer additional costs and be required to pursue new third-party relationships, which could materially disrupt our operations and our ability to provide our products and services, and could divert management’s time and resources. It would be difficult to replace some of our third-party vendors, such as our payment card transaction processor, in a timely manner if they were unwilling or unable to provide us with these services in the future, and our business and operations could be adversely affected. If we are unable to complete a transition to a new provider on a timely basis, or at all, we could be forced to temporarily or permanently discontinue certain services, which could disrupt services to our customers and adversely affect our business, financial condition and results of operations. We may also be unable to establish comparable new third-party relationships on as favorable terms or at all, which could materially and adversely affect our business, financial condition and results of operations.

We rely on software licensed from third parties that may be difficult to replace or that could cause errors or failures of our online platform that could lead to lost customers or harm to our reputation.

We rely on certain cloud-based software licensed from third parties to run our business. For example, we utilize Oracle Corporation’s RightNow cloud solution to manage our customer relations. This software may not continue to be available to us on commercially reasonable terms

 

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and any loss of the right to use any of this software could result in delays in the provisioning of our products and services until equivalent technology is either developed by us, or, if available, is identified, obtained and integrated, which could harm our business. In addition, we have certain service level agreements with our customers for which the availability of this software is critical. Any decrease in the availability of our service as a result of errors, defects, a disruption or failure of our licensed software may require us to provide significant fee credits or refunds to our customers. Our software licensed from third parties is also subject to change or upgrade, which may result in our incurring significant costs to implement such changes or upgrades.

We must adequately protect our brand and the intellectual property rights related to our products and services and avoid infringing on the proprietary rights of others.

We believe that the HealthEquity brand is critical to the success of our business, and we utilize trademark registration and other means to protect it. Our business would be harmed if we were unable to protect our brand against infringement and its value was to decrease as a result.

We rely on a combination of trademark and copyright laws, trade secret protection and confidentiality and license agreements to protect the intellectual property rights related to our products and services. We may unknowingly violate the intellectual property or other proprietary rights of others and, thus, may be subject to claims by third parties. If so, we may be required to devote significant time and resources to defending against these claims or to protecting and enforcing our own rights. Some of our intellectual property rights may not be protected by intellectual property laws, particularly in foreign jurisdictions. The loss of our intellectual property or the inability to secure or enforce our intellectual property rights or to defend successfully against an infringement action could harm our business, results of operations, financial condition and prospects.

If we fail to develop widespread brand awareness cost-effectively, our business may suffer.

We believe that developing and maintaining widespread awareness of our brand in a cost-effective manner is critical to achieving widespread acceptance of our products and services and attracting new customers and strategic partners. Brand promotion activities may not generate customer awareness or increase revenue, and even if they do, any increase in revenue may not offset the expenses we incur in building our brand. If we fail to successfully promote and maintain our brand, or incur substantial expenses, we may fail to attract or retain a sufficient number of customers and strategic partners necessary to realize a sufficient return on our brand-building efforts, or to achieve the widespread brand awareness that is critical for broad customer adoption of our products and services.

We have in the past completed acquisitions and may acquire or invest in other companies or technologies in the future, which could divert management’s attention, fail to meet our expectations, result in additional dilution to our stockholders, increase expenses, disrupt our operations and harm our operating results.

We have in the past acquired, and we may in the future acquire or invest in, businesses, products or technologies that we believe could complement or expand our products and services, enhance our technical capabilities or otherwise offer growth opportunities. We cannot assure you that we will realize the anticipated benefits of these or any future acquisitions. The pursuit of potential acquisitions may divert the attention of management and cause us to incur various expenses related to identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated.

 

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There are inherent risks in integrating and managing acquisitions. If we acquire additional businesses, we may not be able to assimilate or integrate the acquired personnel, operations and technologies successfully or effectively manage the combined business following the acquisition, and our management may be distracted from operating our business. We also may not achieve the anticipated benefits from the acquired business due to a number of factors, including, without limitation:

 

 

unanticipated costs or liabilities associated with the acquisition;

 

 

incurrence of acquisition-related costs, which would be recognized as a current period expense;

 

 

inability to generate sufficient revenue to offset acquisition or investment costs;

 

 

the inability to maintain relationships with customers and partners of the acquired business;

 

 

the difficulty of incorporating acquired technology and rights into our platform and of maintaining quality and security standards consistent with our brand;

 

 

the need to integrate or implement additional controls, procedures and policies;

 

 

harm to our existing business relationships with customers and strategic partners as a result of the acquisition;

 

 

the diversion of management’s time and resources from our core business;

 

 

the potential loss of key employees;

 

 

use of resources that are needed in other parts of our business and diversion of management and employee resources;

 

 

our ability to coordinate organizations that are geographically diverse and that have different business cultures;

 

 

our ability to comply with the regulatory requirements applicable to the acquired business;

 

 

the inability to recognize acquired revenue in accordance with our revenue recognition policies; and

 

 

use of substantial portions of our available cash or the incurrence of debt to consummate the acquisition.

Acquisitions also increase the risk of unforeseen legal liability, including for potential violations of applicable law or industry rules and regulations, arising from prior or ongoing acts or omissions by the acquired businesses which are not discovered by due diligence during the acquisition process. Generally, if an acquired business fails to meet our expectations, our operating results, business and financial condition may suffer. Acquisitions could also result in dilutive issuances of equity securities or the incurrence of debt, which could adversely affect our business, results of operations or financial condition. Even if we are successful in completing and integrating an acquired business, the acquired businesses may not perform as we expect or enhance the value of our business as a whole.

 

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Our quarterly operating results may fluctuate significantly from period to period, which could adversely impact the value of our common stock.

Our quarterly operating results, including our revenue, gross profit, net income and cash flows, may vary significantly in the future, which could cause our stock price to decline rapidly, may lead analysts to change their long-term models for valuing our common stock, could cause short-term liquidity issues, may impact our ability to retain or attract key personnel or cause other unanticipated issues. If our quarterly operating results or guidance fall below the expectations of research analysts or investors, the price of our common stock could decline substantially. Our quarterly operating expenses and operating results may vary significantly in the future and period-to-period comparisons of our operating results may not be meaningful. You should not rely on the results of one quarter as an indication of future performance.

We have recorded a significant amount of intangible assets. We may need to record write-downs from future impairments of identified intangible assets and goodwill, which could adversely affect our costs and business operations.

Our consolidated balance sheet includes significant intangible assets, including approximately $4.7 million in goodwill and $25.4 million in intangible assets, together representing approximately 54% of our unaudited total assets as of April 30, 2014. The determination of related estimated useful lives and whether these assets are impaired involves significant judgments and our ability to accurately predict future cash flows related to these intangible assets may not be accurate. We test our goodwill for impairment each fiscal year, but we also test goodwill and other intangible assets for impairment at any time when there is a change in circumstances that indicates that the carrying value of these assets may be impaired. Any future determination that these assets are carried at greater than their fair value could result in substantial non-cash impairment charges, which could significantly impact our reported operating results.

If we are unable to meet or exceed the net worth test required by the Internal Revenue Service, or IRS, we could be unable to maintain our non-bank custodian status, which would have a material adverse impact on our ability to operate our business.

As a non-bank custodian, we are required to comply with Treasury Regulations Section 1.408-2(e), or the Treasury Regulations, including the net worth requirements set forth therein. If we should fail to comply with the Treasury Regulations’ non-bank custodian requirements, including the net worth requirements, we could be unable to accept new custodial assets or be unable to rely on our previously granted IRS Notice of Approval to serve as a non-bank custodian, which would have a material adverse impact on our business operations. Net worth is defined for this purpose as the amount of our assets less the amount of our liabilities, as determined in accordance with U.S. generally accepted accounting principles. If we fail to comply with the Treasury Regulations, including the net worth requirements, such failure would materially and adversely affect our ability to maintain our current custodial accounts and grow by adding additional custodial accounts, and it could result in the institution of procedures for the revocation of our authorization to operate as a non-bank custodian.

Failure to manage future growth effectively could have a material adverse effect on our business, financial condition and results of operations.

The continued rapid expansion and development of our business may place a significant strain upon our management and administrative, operational and financial infrastructure. As of April 30, 2014, we had approximately 1.0 million HSA Members and $1.7 billion in AUM representing

 

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growth of 45% and 39%, respectively, from April 30, 2013. For the year ended January 31, 2014, our total revenue and Adjusted EBITDA were approximately $62.0 million and $15.8 million, respectively, which represents two-year compounded annual growth rates of approximately 41% and 77%, respectively. See “Selected consolidated financial and other data” for the definition of Adjusted EBITDA and a reconciliation of net income, the most comparable GAAP measure, to Adjusted EBITDA. While to date we believe we have effectively managed the effect on our operations resulting from the rapid growth of our business, our growth strategy contemplates further increasing the number of our HSA Members and our AUM at relatively similar growth rates. However, the rate at which we have been able to attract new HSA Members in the past may not be indicative of the rate at which we will be able to attract additional HSA Members in the future.

Our success will depend in part upon the ability of our executive officers to manage growth effectively. Our ability to grow also depends upon our ability to successfully hire, train, supervise, and manage new employees, obtain financing for our capital needs, expand our systems effectively, control increasing costs, allocate our human resources optimally, maintain clear lines of communication between our operational functions and our finance and accounting functions, and manage the pressures on our management and administrative, operational and financial infrastructure. There can be no assurance that we will be able to accurately anticipate and respond to the changing demands we will face as we continue to expand our operations or that we will be able to manage growth effectively or to achieve further growth at all. Similarly, there can be no assurance that we will be able to effectively control the increasing costs and manage the additional demands placed on our finance and accounting staff and on our financial, accounting and information systems caused by our need to comply with public company requirements, such as those relating to disclosure controls and procedures and internal control over financial reporting. If our business does not continue to grow or if we fail to effectively manage any future growth, our business, financial condition and results of operations could be materially and adversely affected.

We must be able to operate and scale our technology effectively to match our business growth.

Our ability to continue to provide our products and services to a growing number of customers, as well as to enhance our existing products and services, attract new customers and strategic partners, and offer new products and services, is dependent on our information technology systems. If we are unable to manage the technology associated with our business effectively, we could experience increased costs, reductions in system availability and customer loss. We are currently investing in significant upgrading of the capacity and performance of our proprietary technology platform and database design to ensure continued performance at scale, to reduce spending on maintenance activities, and to enable us to execute technology innovation more quickly. If we are unsuccessful in implementing these upgrades to our platform, we may be unable to adequately meet the needs of our customers and/or implement technology-based innovation in response to a rapidly changing market, which could harm our reputation and adversely impact our business, financial condition and results of operations.

We plan to extend and expand our products and services and introduce new products and services, and we may not accurately estimate the impact of developing, introducing and updating these products and services on our business.

We intend to continue to invest in technology and development to create new and enhanced products and services to offer our customers. During this past year, we have added several new features to our platform and have continued to enhance the platform’s mobile compatibility. We

 

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also introduced mobile apps on the Android and iOS platforms. We may not be able to anticipate or manage new risks and obligations or legal, compliance or other requirements that may arise in these areas. The anticipated benefits of such new and improved products and services may not outweigh the costs and resources associated with their development. Some new services may be received negatively by our existing and/or potential customers and strategic partners and have to be put on hold or cancelled entirely.

Our ability to attract and retain new customer revenue from existing customers will depend in large part on our ability to enhance and improve our existing products and services and to introduce new products and services. The success of any enhancement or new product or service depends on several factors, including the timely completion, introduction and market acceptance of the enhancement or new product or service. Any new product or service we develop or acquire may not be introduced in a timely or cost-effective manner and may not achieve the broad market acceptance necessary to generate significant revenue. If we are unable to successfully develop or acquire new products or services or enhance our existing products or services to meet member or network partner requirements, our results of operations, financial condition, business or prospects may be materially adversely affected.

Developing and implementing new and updated applications, features and services for our technology platform may be more difficult than expected, may take longer and cost more than expected and may not result in sufficient increases in revenue to justify the costs.

Attracting and retaining new customers require us to continue to improve the technology underlying our proprietary technology platform. Accordingly, we must continue to develop new and updated applications, features and services. If we are unable to do so on a timely basis or if we are unable to implement new applications, features and services that enhance our customers’ experience without disruption to our existing ones, we may lose potential and existing customers. We rely on a combination of internal development, strategic relationships, licensing and acquisitions to develop our content offerings and healthcare saving and spending services. These efforts may:

 

 

cost more than expected;

 

take longer than originally expected;

 

require more testing than originally anticipated;

 

require additional advertising and marketing costs; and

 

require the acquisition of additional personnel and other resources.

The revenue opportunities generated from these efforts may fail to justify the amounts spent.

Any failure to offer high-quality customer support services could adversely affect our relationships with our customers and strategic partners and our operating results.

Our customers depend on our support and customer education organizations to educate them about, and resolve technical issues relating to, our products and services. We may be unable to respond quickly enough to accommodate short-term increases in customer demand for education and support services. Increased customer demand for these services, without a corresponding increase in revenue, could increase costs and adversely affect our operating results. In addition, our sales process is highly dependent on the reputation of our products and services and business and on positive recommendations from our existing customers. Any failure to maintain high-quality education and technical support, or a market perception that we do not maintain high-quality education support, could adversely affect our reputation, our ability to sell our products

 

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and services to existing and prospective customers and our business and operating results. We promote 24/7/365 education and support along with our proprietary technology platform. Interruptions or delays that inhibit our ability to meet that standard may hurt our reputation or ability to attract and retain customers.

We rely on our management team and key employees and our business could be harmed if we are unable to retain qualified personnel.

Our success depends, in part, on the skills, working relationships and continued services of our founder and senior management team and other key personnel. While we have entered into offer letters or employment agreements with certain of our executive officers, all of our employees are “at-will” employees, and their employment can be terminated by us or them at any time, for any reason and without notice, subject, in certain cases, to severance payment rights. In order to retain valuable employees, in addition to salary and cash incentives, we provide stock options that vest over time or based on performance. The value to employees of stock options that vest over time or based on performance will be significantly affected by movements in our stock price that are beyond our control and may at any time be insufficient to counteract offers from other organizations. The departure of key personnel could adversely affect the conduct of our business. In such event, we would be required to hire other personnel to manage and operate our business, and there can be no assurance that we would be able to employ a suitable replacement for the departing individual, or that a replacement could be hired on terms that are favorable to us. Volatility or lack of performance in our stock price may affect our ability to attract replacements should key personnel depart.

Our success also depends on our ability to attract, retain, and motivate additional skilled management personnel. Although we have not historically experienced unique difficulties attracting qualified employees, we could experience such problems in the future. For example, competition for qualified personnel in our field is intense due to the limited number of individuals who possess the skills and experience required by our industry. In addition, we have experienced employee turnover and expect to continue to experience employee turnover in the future. New hires require significant training and, in most cases, take significant time before they achieve full productivity. New employees may not become as productive as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals. If our retention efforts are not successful or our employee turnover rate increases in the future, our business will be harmed.

If we cannot maintain our corporate culture as we grow, we could lose the innovation, teamwork, passion and focus on execution that we believe contribute to our success, and our business may be harmed.

We believe that a critical component to our success has been our corporate culture. We have invested substantial time and resources in building our team. As we continue to grow, we may find it difficult to maintain these important aspects of our corporate culture. Any failure to preserve our culture could negatively affect our future success, including our ability to retain and recruit personnel and to effectively focus on and pursue our corporate objectives.

We might require additional capital to support our business in the future, and this capital might not be available on acceptable terms, or at all.

If our cash and cash equivalents balances and any cash generated from operations are not sufficient to meet our future cash requirements, we will need to access additional capital to fund

 

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our operations. We may also need to raise additional capital to maintain compliance with the Treasury Regulations including the net worth requirements set forth therein or to take advantage of new business or acquisition opportunities. We may seek to raise capital by, among other things:

 

 

issuing additional shares of our common stock or other equity securities;

 

issuing debt securities; or

 

borrowing funds under a credit facility.

We may not be able to raise needed cash on a timely basis on terms acceptable to us or at all. Financings, if available, may be on terms that are dilutive or potentially dilutive to our stockholders, and the prices at which new investors might be willing to purchase our common stock could be lower than the initial public offering price of our common stock. The holders of new securities may also receive rights, preferences or privileges that are senior to those of existing holders of our common stock. In addition, if we were to raise cash through a debt financing, the terms of the financing might impose additional conditions or restrictions on our operations that could adversely affect our business. If we require new sources of financing but they are insufficient or unavailable, we would be required to modify our operating plans to take into account the limitations of available funding, which would harm our ability to maintain or grow our business.

Our ability to limit our liabilities by contract or through insurance may be ineffective or insufficient to cover our future liabilities.

We attempt to limit, by contract, our liability for damages arising from our negligence, errors, mistakes or security breaches. Contractual limitations on liability, however, may not be enforceable or may otherwise not provide sufficient protection to us from liability for damages. We maintain liability insurance coverage, including coverage for errors and omissions. It is possible, however, that claims could exceed the amount of our applicable insurance coverage, if any, or that this coverage may not continue to be available on acceptable terms or in sufficient amounts. Even if these claims do not result in liability to us, investigating and defending against them could be expensive and time-consuming and could divert management’s attention away from our operations. In addition, negative publicity caused by these events may delay market acceptance of our products and services, any of which could materially and adversely affect our reputation and our business.

We may not be able to adequately protect our intellectual property rights and efforts to protect them may be costly and may substantially harm our business.

Our future success and competitive position are dependent in part upon our ability to protect our intellectual property rights. We have largely relied, and expect to continue to rely, on copyright, trade secret and trademark laws, as well as generally relying on confidentiality procedures and agreements with our employees, consultants, customers and vendors, to control access to, and distribution of, technology, software, documentation and other confidential information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain, use or distribute our technology without authorization. If this were to occur, we could lose revenue as a result of competition from products infringing or misappropriating our technology and intellectual property and we may be required to initiate litigation to protect our proprietary rights and market position. U.S. copyright, trademark and trade secret laws offer us only limited

 

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protection and the laws of some foreign countries do not protect proprietary rights to the same extent. Accordingly, defense of our trademarks and proprietary technology may become an increasingly important issue as we continue to expand our operations.

Policing unauthorized use of our trademarks and technology is difficult and the steps we take may not prevent misappropriation of the trademarks or technology on which we rely. If competitors are able to use our trademarks or technology without recourse, our ability to compete would be harmed and our business would be materially and adversely affected.We may elect to initiate litigation in the future to enforce or protect our proprietary rights or to determine the validity and scope of the rights of others. That litigation may not ultimately be successful and could result in substantial costs to us, the reduction or loss in intellectual property protection for our technology, the diversion of our management’s attention and harm to our reputation, any of which could materially and adversely affect our business and results of operations.

Confidentiality arrangements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.

We have devoted substantial resources to the development of our technology, business operations and business plans. In order to protect our trade secrets and proprietary information, we rely in significant part on confidentiality arrangements with our employees, independent contractors, advisers and customers. These arrangements may not be effective to prevent disclosure of confidential information, including trade secrets, and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover trade secrets and proprietary information, and in such cases we would not be able to assert trade secret rights against such parties. The loss of trade secret protection could make it easier for third parties to compete with our products and services by copying functionality. In addition, any changes in, or unexpected interpretations of, the trade secret and other intellectual property laws may compromise our ability to enforce our trade secret and intellectual property rights. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

Intellectual property claims against us could be costly and result in the loss of significant rights related to, among other things, our website and advertising and marketing activities.

Trademark, copyright and other intellectual property rights are important to us and our business. Our intellectual property rights extend to our technologies, applications and the content on our website. We also rely on intellectual property licensed from third parties. From time to time, third parties may allege that we have violated their intellectual property rights. If we are forced to defend ourselves against intellectual property infringement claims, regardless of the merit or ultimate result of such claims, we may face costly litigation, diversion of technical and management personnel, limitations on our ability to use our website or inability to market or provide our products and services. As a result of any such dispute, we may have to:

 

 

develop non-infringing technology;

 

pay damages;

 

enter into royalty or licensing agreements;

 

cease providing certain products or services; or

 

take other actions to resolve the claims.

 

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If we cannot protect our domain name, our ability to successfully promote our brand will be impaired.

We currently own the web domain name www.healthequity.com, which is critical to the operation of our business. The acquisition and maintenance of domain names, or Internet addresses, is generally regulated by governmental agencies and their designees. The regulation of domain names in the U.S. and in foreign countries is subject to change. Governing bodies may establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names. As a result, we may be unable to acquire or maintain relevant domain names in all countries in which we conduct business. Furthermore, it is unclear whether laws protecting trademarks and similar proprietary rights will be extended to protect domain names. Therefore, we may be unable to prevent third parties from acquiring domain names that are similar to, infringe upon or otherwise decrease the value of our trademarks and other proprietary rights. We may not be able to successfully implement our business strategy of establishing a strong brand for HealthEquity if we cannot prevent others from using similar domain names or trademarks. This failure could impair our ability to increase our market share and revenue.

If one or more jurisdictions successfully assert that we should have collected or in the future should collect additional sales and use taxes on our fees, we could be subject to additional liability with respect to past or future sales and the results of our operations could be adversely affected.

We do not collect sales and use taxes in all jurisdictions in which our customers are located, based on our belief that such taxes are not applicable. Sales and use tax laws and rates vary by jurisdiction and such laws are subject to interpretation. In those jurisdictions and in those cases where we do believe sales taxes are applicable, we collect and file timely sales tax returns. Currently, such taxes are minimal. Jurisdictions in which we do not collect sales and use taxes may assert that such taxes are applicable, which could result in the assessment of such taxes, interest and penalties, and we could be required to collect such taxes in the future. This additional sales and use tax liability could adversely affect the results of our operations.

Our online platform is hosted from two data centers. Any disruption of service at our facilities or our third-party hosting providers could interrupt or delay our customers’ access to our products and services, which could harm our operating results.

The ability of our employees, members, Health Plan Partners and Employer Partners to access our technology platform is critical to our business. We currently serve our customers from data centers located in Draper, Utah, with a backup site in Austin, Texas. We cannot ensure that the measures we have taken will be effective to prevent or minimize interruptions to our operations. Our facilities are vulnerable to interruption or damage from a number of sources, many of which are beyond our control, including, without limitation:

 

 

extended power loss;

 

 

telecommunications failures from multiple telecommunications providers;

 

 

natural disaster or an act of terrorism;

 

 

software and hardware errors, or failures in our own systems or in other systems;

 

 

network environment disruptions such as computer viruses, hacking and similar problems in our own systems and in other systems;

 

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theft and vandalism of equipment; and

 

 

actions or events caused by or related to third parties.

We attempt to mitigate these risks through various business continuity efforts, including redundant infrastructure, 24/7/365 system activity monitoring, backup and recovery procedures, use of a secure off-site storage facility for backup media, separate test systems and change management and system security measures, but our precautions may not protect against all potential problems. Our data recovery center is equipped with physical space, power, storage and networking infrastructure and Internet connectivity to support our online platform in the event of the interruption of services at our primary data center. Even with this data recovery center, however, our operations would be interrupted during the transition process should our primary data center experience a failure. Disruptions at our data centers could cause disruptions to our online platform and data loss or corruption. We have experienced interruptions and delays in service and availability for data centers, bandwidth and other technologies in the past. Any future errors, failure, interruptions or delays experienced in connection these third-party technologies could delay our customers’ access to our products, which would harm our business. This could damage our reputation, subject us to potential liability or costs related to defending against claims or cause our customers and strategic partners to cease doing business with us, any of which could negatively impact our revenue.

Interruption or failure of our information technology and communications systems could impair our ability to effectively deliver our products and services, which could cause us to lose customers and harm our operating results.

Our business depends on the continuing operation of our technology infrastructure and systems. Any damage to or failure of our systems could result in interruptions in our ability to deliver our products and services. Interruptions in our service could reduce our revenue and profits, and our reputation could be damaged if people believe our systems are unreliable. Our systems and operations are vulnerable to damage or interruption from earthquakes, terrorist attacks, floods, fires, power loss, break-ins, hardware or software failures, telecommunications failures, computer viruses or other attempts to harm our systems and similar events.

Any unscheduled interruption in our service would result in an immediate loss of revenue. Frequent or persistent system failures that result in the unavailability of our platform or slower response times could reduce our customers’ ability to access our platform, impair our delivery of our products and services and harm the perception of our platform as reliable, trustworthy and consistent. Our insurance policies provide only limited coverage for service interruptions and may not adequately compensate us for any losses that may occur due to any failures or interruptions in our systems.

Acts of terrorism, acts of war and other unforeseen events may cause damage or disruption to us or our customers, which could materially and adversely affect our business, financial condition and operating results.

Natural disasters, acts of war, terrorist attacks and the escalation of military activity in response to such attacks or otherwise may have negative and significant effects, such as imposition of increased security measures, changes in applicable laws, market disruptions and job losses. Such events may have an adverse effect on the economy in general. Moreover, the potential for future terrorist attacks and the national and international responses to such threats could affect the

 

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business in ways that cannot be predicted. The effect of any of these events or threats could have a material adverse effect on our business, financial condition and results of operations.

Risks relating to this offering and owning our common stock

An active trading market for our common stock may not develop and the market price for our common stock may decline below the initial public offering price.

Prior to this offering, there has not been a public market for our common stock. An active trading market for our common stock may never develop or be sustained, which could adversely impact your ability to sell your shares and could depress the market price of your shares. In addition, the public offering price for our common stock has been determined through negotiations among us and the representatives of the underwriters and may not be indicative of prices that will prevail in the open market upon completion of this offering. Consequently, you may be unable to sell your shares of our common stock at prices equal to or greater than the price you paid for them.

We have identified a material weakness in our financial reporting and may identify additional material weaknesses in the future that may cause us to fail to meet our reporting obligations or result in material misstatements of our financial statements. If we have failed to remediate our material weakness or if we fail to maintain effective control over financial reporting, our ability to accurately and timely report our financial results could be adversely affected.

In connection with our preparation for this offering, we concluded that there was a material weakness in our financial reporting that caused the restatement of our previously issued financial statements as of and for the year ended January 31, 2013. A material weakness is a deficiency, or a combination of deficiencies, in financial reporting such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.

The material weakness we identified comprises our lack of sufficient expertise to appropriately address and timely account for complex, non-routine transactions in accordance with U.S. generally accepted accounting principles. The evidence of this material weakness relates primarily to the measurement and classification of redeemable convertible preferred stock and warrants issued in connection with the redeemable convertible preferred stock.

For a discussion of the remediation plan that we executed, see “Management’s discussion and analysis of financial condition and results of operations—Internal control over financial reporting.” However, if we have not successfully remediated this material weakness, and if we are unable to produce accurate and timely financial statements, our stock price may be adversely affected and we may be unable to maintain compliance with applicable NASDAQ listing requirements.

The market price of our common stock is likely to be volatile and could decline following this offering, resulting in a substantial loss of your investment.

The stock market in general has been highly volatile. As a result, the market price and trading volume for our common stock may also be highly volatile, and investors in our common stock may experience a decrease in the value of their shares, including decreases unrelated to our

 

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operating performance or prospects. Factors that could cause the market price of our common stock to fluctuate significantly include:

 

 

our operating and financial performance and prospects and the performance of other similar companies;

 

 

our quarterly or annual earnings or those of other companies in our industry;

 

 

conditions that impact demand for our products and services;

 

 

the public’s reaction to our press releases, financial guidance and other public announcements, and filings with the SEC;

 

 

changes in earnings estimates or recommendations by securities or research analysts who track our common stock;

 

 

market and industry perception of our success, or lack thereof, in pursuing our growth strategy;

 

 

strategic actions by us or our competitors, such as acquisitions or restructurings;

 

 

changes in government and other regulations;

 

 

changes in accounting standards, policies, guidance, interpretations or principles;

 

 

arrival and departure of key personnel;

 

 

the number of shares to be publicly traded after this offering;

 

 

sales of common stock by us, our investors or members of our management team; and

 

 

changes in general market, economic and political conditions in the U.S. and global economies or financial markets, including those resulting from natural disasters, telecommunications failure, cyber attack, civil unrest in various parts of the world, acts of war, terrorist attacks or other catastrophic events.

Any of these factors may result in large and sudden changes in the trading volume and market price of our common stock and may prevent you from being able to sell your shares at or above the price you paid for your shares of our common stock. Following periods of volatility in the market price of a company’s securities, stockholders often file securities class-action lawsuits against such company. Our involvement in a class-action lawsuit could divert our senior management’s attention and, if adversely determined, could have a material and adverse effect on our business, financial condition and results of operations.

Future sales of shares by existing stockholders could cause our stock price to decline.

Sales of substantial amounts of our common stock in the public market following this offering, or the perception that these sales could occur, could cause the market price of our common stock to decline. Based on shares outstanding as of                 , 2014 upon completion of this offering, we will have                 shares of our common stock outstanding (or                 shares, assuming full exercise of the underwriters’ option to purchase additional shares). All of the shares sold pursuant to this offering will be immediately tradable without restriction under the Securities Act unless held by “affiliates,” as that term is defined in Rule 144 under the Securities Act. The

 

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remaining                 shares outstanding will be restricted securities within the meaning of Rule 144 under the Securities Act but will be eligible for resale subject to applicable volume, means of sale, holding period and other limitations of Rule 144 or pursuant to an exception from registration under Rule 701 under the Securities Act, subject to the terms of the lock-up agreements entered into among the underwriters, our directors, officers, and substantially all of our securityholders. J.P. Morgan Securities LLC and Wells Fargo Securities, LLC, the representatives of the underwriters, may, in their sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements entered into in connection with this offering. See “Underwriting.” Upon completion of this offering, we intend to file one or more registration statements under the Securities Act to register the shares of our common stock to be issued under our equity compensation plans and, as a result, all shares of our common stock acquired upon exercise of options granted under our plans will also be freely tradable under the Securities Act, subject to the terms of the lock-up agreements, unless purchased by our affiliates. A total of             shares of common stock are reserved for issuance under our equity compensation plans.

We, our executive officers, directors and substantially all of our securityholders have agreed to a “lock-up,” meaning that, subject to certain exceptions, neither we nor they will sell any shares without the prior consent of J.P. Morgan Securities LLC and Wells Fargo Securities, LLC, for 180 days after the date of this prospectus. Following the expiration of this 180-day lock-up period,                 shares of our common stock will be eligible for future sale, subject to the applicable volume, manner of sale, holding period and other limitations of Rule 144. See “Shares eligible for future sale” for a discussion of the shares of our common stock that may be sold into the public market in the future. In addition, certain of our significant stockholders may distribute shares that they hold to their investors who themselves may then sell into the public market following the expiration of the lock-up period. Such sales may not be subject to the volume, manner of sale, holding period and other limitations of Rule 144. As resale restrictions end, the market price of our common stock could decline if the holders of those shares sell them or are perceived by the market as intending to sell them. In addition, holders of approximately                 shares, or     %, of             our common stock will have registration rights, subject to some conditions, to require us to file registration statements covering the sale of their shares or to include their shares in registration statements that we may file for ourselves or other stockholders in the future. Once we register the shares for the holders of registration rights, they can be freely sold in the public market upon issuance, subject to the restrictions contained in the lock-up agreements.

In the future, we may issue additional shares of common stock or other equity or debt securities convertible into common stock in connection with a financing, acquisition, and litigation settlement or employee arrangement or otherwise. Any of these issuances could result in substantial dilution to our existing stockholders and could cause the trading price of our common stock to decline.

Our principal stockholder owns a significant percentage of our shares and will be able to exert significant control over matters subject to stockholder approval.

As of May 31, 2014, our principal stockholder, Berkley, owned approximately 36.8% of our outstanding voting shares and, upon completion of this offering, will hold approximately         % of our outstanding voting shares. Therefore, even after this offering, Berkley may have the ability to influence us through its ownership position. Berkley may be able to determine all matters

 

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requiring stockholder approval. For example, it may be able to control elections of directors, amendments of our organizational documents, or approval of any merger, sale of assets, or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common shares that you may feel are in your best interest as one of our stockholders. In addition, our amended and restated certificate of incorporation and amended and restated bylaws will not permit cumulative voting in the election of directors. The absence of cumulative voting makes it more difficult for a minority stockholder to gain a seat on our board of directors to influence our board’s decision regarding a takeover.

If securities or industry analysts do not publish research or publish misleading or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We do not currently have and may never obtain research coverage by securities and industry analysts. If there is no coverage of our company by securities or industry analysts, the trading price for our shares would be negatively impacted. In the event we obtain securities or industry analyst coverage or if one or more of these analysts downgrades our shares or publishes misleading or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our shares could decrease, which could cause our stock price or trading volume to decline.

We are an “emerging growth company,” and any decision on our part to comply only with certain reduced disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act, or the JOBS Act, enacted in April 2012, and, for as long as we continue to be an emerging growth company, we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies, including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved.

In addition, Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we are choosing to opt out of such extended transition period, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

We could remain an emerging growth company for up to five years, or until the earliest of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1 billion, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if, among other things, the market value of common equity securities held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1 billion in nonconvertible debt during the preceding three-year period.

 

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We cannot predict whether investors will find our common stock less attractive if we choose to rely on one or more of these exemptions. If some investors find our common stock less attractive as a result of any decisions to reduce future disclosure, there may be a less active trading market for our common stock and our stock price may be more volatile.

The requirements of being a public company may strain our resources and distract our management, which could make it difficult to manage our business, particularly after we are no longer an emerging growth company.

We have historically operated as a private company and have not been subject to the same financial and other reporting and corporate governance requirements as a public company. After this offering, we will be required to file annual, quarterly and other reports with the SEC. We will need to prepare and timely file financial statements that comply with SEC reporting requirements. We will also be subject to other reporting and corporate governance requirements, under the listing standards of NASDAQ and the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, which will impose significant compliance costs and obligations upon us. The changes necessitated by becoming a public company will require a significant commitment of additional resources and management oversight which will increase our operating costs. These changes will also place significant additional demands on our finance and accounting staff, which may not have prior public company experience or experience working for a newly public company, and on our financial accounting and information systems. We may in the future hire additional accounting and financial staff with appropriate public company reporting experience and technical accounting knowledge. Other expenses associated with being a public company include increases in auditing, accounting and legal fees and expenses, investor relations expenses, increased directors’ fees and director and officer liability insurance costs, registrar and transfer agent fees and listing fees, as well as other expenses. As a public company, we will be required, among other things, to:

 

 

prepare and file periodic reports, and distribute other stockholder communications, in compliance with the federal securities laws and NASDAQ rules;

 

 

define and expand the roles and the duties of our board of directors and its committees;

 

 

institute more comprehensive compliance, investor relations and internal audit functions; and

 

 

evaluate and maintain our system of internal control over financial reporting, and report on management’s assessment thereof, in compliance with rules and regulations of the SEC and the Public Company Accounting Oversight Board.

In particular, upon completion of this offering, Sarbanes-Oxley will require us to document and test the effectiveness of our internal control over financial reporting in accordance with an established internal control framework, and to report on our conclusions as to the effectiveness of our internal controls. Likewise, our independent registered public accounting firm will be required to provide an attestation report on the effectiveness of our internal control over financial reporting pursuant to Section 404(b) of Sarbanes-Oxley unless we choose to utilize the exemption from such attestation requirement available to emerging growth companies. As described in the previous risk factor, we expect to qualify as an emerging growth company upon completion of this offering and could potentially qualify as an emerging growth company until January 31, 2020. In addition, upon completion of this offering, we will be required under the Securities Exchange Act of 1934, as amended, or the Exchange Act, to maintain disclosure controls and procedures and internal control over financial reporting. Any failure to implement

 

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required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we are unable to conclude that we have effective internal control over financial reporting, investors could lose confidence in the reliability of our financial statements. This could result in a decrease in the value of our common stock. Failure to comply with Sarbanes-Oxley could potentially subject us to sanctions or investigations by the SEC or other regulatory authorities.

We have broad discretion to use the proceeds from the offering and our investment of those proceeds may not yield favorable returns.

Our management has broad discretion to spend the proceeds from this offering and you may not agree with the way the proceeds are spent. The failure of our management to apply these funds effectively could result in unfavorable returns. This could adversely affect our business, causing the price of our common stock to decline.

We do not intend to pay regular cash dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

Except for the previously declared cash dividend payable on shares of our common stock and convertible preferred stock outstanding on the day immediately prior to the closing date of this offering, we have no current plans to declare and pay any cash dividends for the foreseeable future. We currently intend to retain all our future earnings, if any, to fund our growth. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future and the success of an investment in our common stock will depend upon any future appreciation in its value. There is no guarantee that our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.

If we are unable to implement and maintain effective internal controls over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be adversely affected.

As a public company, we will be required to maintain internal controls over financial reporting and to report any material weaknesses in such internal controls. Section 404 of Sarbanes-Oxley requires that we evaluate and determine the effectiveness of our internal controls over financial reporting and, beginning with our second annual report following this offering, which will be for our year ending January 31, 2016, provide a management report on internal controls over financial reporting. Sarbanes-Oxley also requires that our management report on internal controls over financial reporting be attested to by our independent registered public accounting firm, to the extent we are no longer an emerging growth company. We do not expect to have our independent registered public accounting firm attest to our management report on internal controls over financial reporting for so long as we are an emerging growth company.

If we have a material weakness in our internal controls over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated. We are in the process of designing and implementing the internal controls over financial reporting required to comply with this obligation, which process will be time-consuming, costly and complicated. If we identify material weaknesses in our internal controls over financial reporting, if we are unable to comply with the requirements of Section 404 of Sarbanes-Oxley in a timely manner, if we are unable to assert that our internal controls over financial reporting are effective, or if our independent registered public accounting firm is unable to express an opinion

 

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as to the effectiveness of our internal controls over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be adversely affected, and we could become subject to investigations by the stock exchange on which our securities are listed, the SEC or other regulatory authorities, which could require additional financial and management resources.

Future offerings of debt or equity securities, which may rank senior to our common stock, may adversely affect the market price of our common stock.

If we decide to issue debt securities in the future, which would rank senior to shares of our common stock, it is likely that they will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any equity securities or convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock and may result in dilution to owners of our common stock. We and, indirectly, our stockholders will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock will bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their share holdings in us.

Purchasing our common stock through this offering will result in an immediate and substantial dilution of your investment.

The initial public offering price of our common stock is substantially higher than the net tangible book value per share of our common stock. Therefore, if you purchase our common stock in this offering, your interest will be diluted immediately to the extent of the difference between the initial public offering price per share of our common stock and the net tangible book value per share of our common stock after this offering. See “Dilution.”

Furthermore, if we raise additional capital by issuing new convertible or equity securities at a lower price than the initial public offering price, your interest will be further diluted. This may result in the loss of all or a portion of your investment. If our future access to public markets is limited or our performance decreases, we may need to carry out a private placement or public offering of our common stock at a lower price than the initial public offering price. In addition, newer securities may have rights, preferences or privileges senior to those of securities held by you.

Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable.

Certain provisions in our governing documents could make a merger, tender offer or proxy contest involving us difficult, even if such events would be beneficial to the interests of our stockholders. These provisions include the inability of our stockholders to act by written consent and certain advance notice procedures with respect to stockholder proposals and nominations for candidates for the election of directors. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us. Accordingly, our board of directors could rely upon these or other provisions in our governing documents and Delaware law to prevent or delay a transaction involving a change in control of our company, even if doing so would benefit our stockholders. See “Description of capital stock.”

 

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Our amended and restated certificate of incorporation that will be in effect upon completion of this offering will provide that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.

Our amended and restated certificate of incorporation that will be in effect upon completion of this offering provides that the Court of Chancery of the State of Delaware is the exclusive forum for any derivative action or proceeding brought on our behalf, any action asserting a claim for breach of a fiduciary duty owed by any of our directors, officers, employees or agents to us or our stockholders, any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, our certificate of incorporation or our bylaws, or any action asserting a claim governed by the internal affairs doctrine. The choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and other employees. Alternatively, if a court were to find the choice of forum provision contained in our amended and restated certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.

 

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Special note regarding forward-looking statements and industry data

This prospectus includes forward-looking statements that involve risks and uncertainties, including in the sections entitled “Prospectus summary,” “Risk factors,” “Management’s discussion and analysis of financial condition and results of operations,” and “Business.” These forward-looking statements include, without limitation, statements regarding our industry, business strategy, plans, goals and expectations concerning our market position, product expansion, future operations, margins, profitability, future efficiencies, capital expenditures, liquidity and capital resources and other financial and operating information. When used in this discussion, the words “may,” “believes,” “intends,” “seeks,” “anticipates,” “plans,” “estimates,” “expects,” “should,” “assumes,” “continues,” “could,” “will,” “future” and the negative of these or similar terms and phrases are intended to identify forward-looking statements in this prospectus.

Forward-looking statements reflect our current expectations regarding future events, results or outcomes. These expectations may or may not be realized. Although we believe the expectations reflected in the forward-looking statements are reasonable, we can give you no assurance these expectations will prove to have been correct. Some of these expectations may be based upon assumptions, data or judgments that prove to be incorrect. Actual events, results and outcomes may differ materially from our expectations due to a variety of known and unknown risks, uncertainties and other factors. Although it is not possible to identify all of these risks and factors, they include, among others, the following:

 

 

our expectations regarding our operating revenue, expenses, effective tax rates and other results of operations;

 

 

our anticipated capital expenditures and our estimates regarding our capital requirements;

 

 

our ability to stay abreast of new or modified laws and regulations that currently apply or become applicable to our business;

 

 

the growth rates of the markets in which we compete;

 

 

competitive pressures related to the fees that we charge;

 

 

our reliance on key members of executive management and our ability to identify, recruit and retain skilled personnel;

 

 

management compensation and the methodology for its determination;

 

 

our ability to promote our brand;

 

 

disturbance to our information technology systems;

 

 

our ability to protect our intellectual property rights;

 

 

unavailability of capital;

 

 

general economic conditions;

 

 

risk of future legal proceedings; and

 

 

other risks and factors listed under “Risk factors” and elsewhere in this prospectus.

 

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In light of these risks, uncertainties and other factors, the forward-looking statements contained in this prospectus might not prove to be accurate and you should not place undue reliance upon them. All forward-looking statements speak only as of the date made and we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

This prospectus also contains estimates and other information concerning our industry, including market size and growth rates, that are based on industry publications, data from research firms and other third-party sources, surveys, estimates and forecasts, including those generated by Interpro Publications Inc. (Consumer Driven Market Report), Towers Watson and Company, Employee Benefit Research Institute, MRops, Inc., Oxygen Research Inc., Kaiser Family Foundation and Bloom Health. Although we believe the information in these industry publications and third-party sources is generally reliable, this information is inherently imprecise and involves a number of assumptions and limitations, and you are cautioned not to give undue weight to these estimates. In addition, projections, assumptions and estimates of our future performance, industry or market conditions and demographics are inherently imprecise, and the industry in which we operate is subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk factors.”

 

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Use of proceeds

We estimate that our net proceeds from the sale of                 shares of common stock in this offering will be approximately $         million after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters exercise their over-allotment option in full, we estimate that our net proceeds will be approximately $         million after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

A $1.00 increase (decrease) in the assumed initial public offering price of $         per share would increase (decrease) the net proceeds to us from this offering by $         million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. An increase (decrease) of 1.0 million shares in the number of shares offered by us would increase the net proceeds to us from this offering by approximately $         million, assuming the assumed initial public offering price of $         per share remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable.

The principal reasons for this offering are to access the public capital markets and increase our capitalization, financial flexibility and visibility in the marketplace. We intend to use the net proceeds from the sale of common stock by us in this offering:

 

 

to pay a previously declared cash dividend of approximately $         on shares of our common stock, convertible preferred stock, and redeemable convertible preferred stock outstanding on the day immediately prior to the closing date of this offering. Our executive officers, directors, beneficial owners of 5% or more of our outstanding shares of capital stock, and affiliated entities, will receive approximately $         , or    %, of such dividend amount;

 

 

to pay a cash dividend of approximately $         on shares of our outstanding series D-3 redeemable convertible preferred stock accrued through the date of conversion of such shares into common stock, which will occur on the closing date of this offering. Our executive officers, directors, beneficial owners of 5% or more of our outstanding shares of capital stock, and affiliated entities, will receive approximately $         , or    %, of such dividend amount; and

 

 

for working capital and other general corporate purposes, including to finance our growth, hire additional personnel and fund capital expenditures and potential acquisitions.

We may pursue the acquisition of companies or businesses with complementary products and technologies that we believe will enhance our business; however, we do not have agreements or commitments for any specific acquisitions at this time.

Our expected use of the net proceeds from this offering is based upon our present plans and business condition. As of the date of this prospectus, we cannot specify with certainty all of the particular uses of the net proceeds that we receive from this offering. Accordingly, we will have broad discretion in using these proceeds. Furthermore, the amount and timing of our actual expenditures will depend on numerous factors, including the cash used in or generated by our operations, the status of our development activities, the level of our sales and marketing activities, our technology investments and any potential acquisitions. Our management also has discretion over many of these factors.

 

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Pending the use of proceeds from this offering as described above, we plan to invest the net proceeds that we receive in this offering in short-term and intermediate-term interest-bearing obligations, investment-grade investments, certificates of deposit, or direct or guaranteed obligations of the U.S. government.

 

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Dividend policy

During the year ended January 31, 2013, we issued a stock dividend, and during the year ended January 31, 2014 we paid a cash dividend, in each case to the holders of shares of our outstanding series D-3 redeemable convertible preferred stock in accordance with the dividend rights affixed to such class and series of our capital stock. See “Certain relationships and related party transactions—Related person transactions—Series D-3 redeemable convertible preferred stock dividends.” Upon completion of this offering, an aggregate amount of $         is payable on shares of our outstanding series D-3 redeemable convertible preferred stock accrued through the date of conversion of such shares into common stock, which will occur on the closing date of this offering. In addition, our board of directors has declared a cash dividend in an aggregate amount of approximately $         , which is payable on shares of our common stock, convertible preferred stock, and redeemable convertible preferred stock outstanding on the day immediately prior to the closing date of this offering and will be paid out of a portion of the net proceeds of the offering. The dividend will not be paid on any shares purchased in this offering.

Other than the dividend described above, we do not currently intend to pay cash dividends on our common stock and do not anticipate paying any dividends on our common stock in the foreseeable future. Any future determinations relating to our dividend policies will be made at the discretion of our board of directors and will depend on conditions then existing, including our financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors our board of directors may deem relevant.

 

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Capitalization

The following table sets forth our cash and cash equivalents and capitalization as of April 30, 2014:

 

 

on an actual basis without any adjustments to reflect subsequent or anticipated events;

 

 

on a pro forma basis to reflect (1) the automatic conversion of all outstanding shares of our convertible preferred stock and redeemable convertible preferred stock into an aggregate of 32,486,588 shares of our common stock, which will occur immediately prior to the completion of this offering, (2) our board of directors’ declaration of a cash dividend in the amount of $         to holders of our common stock, convertible preferred stock and redeemable convertible preferred stock outstanding on the day immediately prior to the closing date of this offering, and the payment thereof, to be paid from the net proceeds of this offering, (3) the payment of a cash dividend in the amount of $         to holders of our outstanding series D-3 redeemable convertible preferred stock in accordance with the dividend rights affixed to such class and series of our capital stock to be paid from the net proceeds of this offering, and (4) the amendment and restatement of our certificate of incorporation in connection with this offering; and

 

 

on a pro forma as adjusted basis to reflect (1) the transactions described in the preceding clause, and (2) the issuance and sale by us of                 shares of our common stock in this offering, and the receipt of the net proceeds from our sale of these shares at the assumed initial public offering price, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, as if the events had occurred on April 30, 2014.

 

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You should read this table in conjunction with the sections of this prospectus entitled “Selected consolidated financial and other data,” “Management’s discussion and analysis of financial condition and results of operations,” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

      As of April 30, 2014
(in thousands, except per share data)    Actual     Pro forma    Pro forma(1)
as adjusted
         

(unaudited)

  

(unaudited)

Cash and Cash Equivalents

   $ 13,990        
  

 

 

   

 

  

 

Redeemable Convertible Preferred Stock

       

Redeemable Convertible Preferred Stock, $0.0001 par value, 26,473 shares authorized; 17,349 shares issued and outstanding, actual;                      issued and outstanding on a pro forma and pro forma as adjusted basis

   $ 42,693        
  

 

 

      

Stockholders’ Equity

       

Post Initial Public Offering Preferred Stock

   $        

Convertible Preferred Stock, $0.0001 par value, 6,738 shares authorized, 6,156 shares issued and outstanding, actual;                  shares authorized, issued and outstanding on a pro forma and pro forma as adjusted basis

     8,129        

Common Stock, $0.0001 par value, 70,000 shares authorized, 7,038 shares issued and outstanding, actual;                      issued and outstanding on a pro forma and pro forma as adjusted basis

     1        

Common Stock Warrants

     2,259        

Additional Paid-in Capital

     11,880        

Accumulated Deficit

     (20,621     
  

 

 

      

Total Stockholders’ Equity

     1,648        
  

 

 

      

Total Capitalization

   $ 44,341        

 

 

(1)   Each $1.00 increase (decrease) in the assumed initial public offering price per share would increase (decrease) each of cash and cash equivalents, additional paid-in capital, total stockholders’ equity (deficit) and total capitalization by $        million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. An increase (decrease) of 1.0 million shares in the number of shares offered by us would increase (decrease) each of cash and cash equivalents, additional paid-in capital, total stockholders’ equity (deficit) and total capitalization by $        million, assuming the assumed initial public offering price per share remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual public offering price and terms of this offering determined at pricing.

The table above is based on the number of shares of our common stock outstanding as of April 30, 2014, and excludes:

 

 

6,189,550 shares of our common stock issuable upon the exercise of outstanding stock options as of April 30, 2014, at a weighted average exercise price of $1.78 per share, of which 3,464,350 options are exercisable as of such date;

 

 

2,571,324 shares of common stock issuable upon the exercise of outstanding warrants as of April 30, 2014 at a weighted average exercise price of $0.77 per share, certain of which outstanding warrants will be automatically cancelled upon the closing of this offering if not previously exercised; and

 

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454,500 shares of our common stock reserved for future grant or issuance under our 2014 Equity Incentive Plan, which will be amended and restated in connection with the completion of this offering. See “Executive compensation—Additional incentive compensation plans and awards—2014 equity incentive plan.”

 

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Dilution

If you invest in our common stock in this offering, your interest will be immediately diluted to the extent of the difference between the initial public offering price per share and the pro forma as adjusted net tangible book value per share of our common stock immediately after this offering. Our pro forma net tangible book value as of April 30, 2014 was $         million, or $         per share of common stock. Net tangible book value per share is determined by dividing our total tangible assets less total liabilities by the number of shares of our common stock outstanding as of April 30, 2014, after giving effect to the conversion of all outstanding shares of our convertible preferred stock into shares of common stock immediately prior to the completion of this offering.

Our historical net tangible book value (deficit) as of April 30, 2014, was approximately $(28.4) million, or $(3.74) per share of our common stock. Our historical net tangible book value is the amount of our total tangible assets less our liabilities and redeemable convertible preferred stock, which is not included within stockholders’ equity (deficit). Historical net tangible book value per share is our historical net tangible book value divided by the number of shares of common stock outstanding as of April 30, 2014.

Our pro forma net tangible book value as of April 30, 2014 was $         million, or $         per share of common stock. Pro forma net tangible book value gives effect to (i) the conversion of all of our outstanding convertible preferred stock and redeemable convertible preferred stock as of April 30, 2014 into an aggregate of 32,486,588 shares of our common stock, (ii) our board of directors’ declaration of a cash dividend to holders of our common stock, convertible preferred stock and redeemable convertible preferred stock outstanding on the day immediately prior to the closing date of this offering, to be paid from the net proceeds of this offering, and (iii) the payment of a cash dividend to holders of our outstanding series D-3 redeemable convertible preferred stock to be paid from the net proceeds of this offering. Net tangible book value per share is determined by dividing our total tangible assets less total liabilities by the number of shares of our common stock outstanding as of April 30, 2014.

After giving effect to the sale by us of shares of common stock in this offering at the assumed initial public offering price, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of April 30, 2014 would have been approximately $         million, or approximately $         per share. This amount represents an immediate increase in pro forma net tangible book value of $         per share to our existing stockholders and an immediate dilution in pro forma net tangible book value of approximately $         per share to new investors purchasing shares of common stock in this offering at the assumed initial public offering price.

The following table illustrates this per share dilution:

 

Assumed initial public offering price per share

           $                

Historical net tangible book value per share as of April 30, 2014

   $ (3.74  

Pro forma increase in net tangible book value per share as of April 30, 2014 attributable to the pro forma transactions described in the preceding paragraphs

    

Pro forma net tangible book value per share as of April 30, 2014

    

Increase in pro forma as adjusted net tangible book value per share attributable to new investors in this offering

    
  

 

 

   

Pro forma as adjusted net tangible book value per share after this offering

     $     
    

 

 

 

Dilution per share to new investors

     $     

 

 

 

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Each $1.00 increase or decrease in the assumed initial public offering price of $         per share would increase or decrease our pro forma as adjusted net tangible book value by approximately $         million, or approximately $         per share, and the dilution per share to investors participating in this offering by approximately $         per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.

If the underwriters exercise their over-allotment option in full, the pro forma as adjusted net tangible book value per share after the offering would be $         per share, the increase in the pro forma net tangible book value per share to existing stockholders would be $             per share and the dilution to new investors purchasing common stock in this offering would be $         per share.

The following table sets forth as of April 30, 2014, on the pro forma basis described above, the differences between the number of shares of common stock purchased from us, the total consideration paid by or received from existing stockholders and the weighted average price per share paid by existing stockholders and by investors purchasing shares of our common stock in this offering at the assumed initial public offering price, before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us:

 

      Shares purchased      Total consideration(1)      Average
price  per
share
 
      Number    Percent          Amount      Percent     

Existing stockholders

            %       $                          %       $                

New investors

              
  

 

 

Total

        100%       $           100%       $     

 

 

 

(1)   A $1.00 increase (decrease) in the assumed initial public offering price would increase (decrease) the total consideration paid to us by new investors and total consideration paid to us by all stockholders by $        million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. An increase (decrease) of 1.0 million shares in the number of shares offered by us would increase (decrease) the total consideration paid to us by new investors and total consideration paid to us by all stockholders by $        million, assuming the assumed initial public offering price remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

If the underwriters exercise their over-allotment option in full, the pro forma as adjusted net tangible book value per share after the offering would be $         per share, the increase in the pro forma net tangible book value per share to existing stockholders would be $         per share and the dilution to new investors participating in this offering would be $         per share.

The foregoing discussion and tables are based on 40,087,756 shares of our common stock outstanding as of April 30, 2014, after giving effect to the conversion of our outstanding convertible preferred stock and redeemable convertible preferred stock as of April 30, 2014 into an aggregate of 32,486,588 shares of common stock and excludes:

 

 

6,189,550 shares of our common stock issuable upon the exercise of outstanding stock options as of April 30, 2014, at a weighted average exercise price of $1.78 per share, of which 3,464,550 options are exercisable as of such date;

 

 

2,571,324 shares of common stock issuable upon the exercise of outstanding warrants as of April 30, 2014 at a weighted average exercise price of $0.77 per share, certain of which outstanding warrants will be automatically cancelled upon the closing of this offering if not previously exercised; and

 

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454,500 shares of our common stock reserved for future grant or issuance under our 2014 Equity Incentive Plan, which will be amended and restated in connection with the completion of this offering. See “Executive compensation—Additional incentive compensation plans and awards—2014 equity incentive plan.”

Furthermore, we may choose to raise additional capital through the sale of equity or convertible debt securities due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. New investors will experience further dilution if any of our outstanding options or warrants are exercised, new options are issued and exercised under our equity incentive plans or we issue additional shares of common stock, other equity securities or convertible debt securities in the future.

 

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Selected consolidated financial and other data

The following tables set forth our selected consolidated statements of operations and comprehensive income and selected consolidated balance sheets data. The selected consolidated statements of operations and comprehensive income for the years ended January 31, 2014 and 2013 and the selected consolidated balance sheets data as of January 31, 2014 and 2013 have been derived from our audited consolidated financial statements and the notes thereto included elsewhere in this prospectus. The consolidated statements of operations and comprehensive income for the three months ended April 30, 2014 and 2013, and the consolidated balance sheet data as of April 30, 2014 have been derived from our unaudited consolidated financial statements appearing elsewhere in this prospectus. Our historical operating results are not necessarily indicative of future operating results, and our interim results are not necessarily indicative of the results to be expected for the full year or any other period.

The following data should be read together with our consolidated financial statements and the related notes thereto, as well as the section entitled “Management’s discussion and analysis of financial condition and results of operations,” included elsewhere in this prospectus.

 

     Three months ended April 30,     Year ended January 31,  
                    2014                     2013                     2014                     2013  
(in thousands)   (Unaudited)     (Unaudited)                

Revenue

       

Account Fee Revenue

  $ 10,388      $ 7,016      $ 30,575      $ 22,102   

Custodial Fee Revenue

    5,427        4,449        18,955        15,181   

Card Fee Revenue

    4,298        3,062        11,931        8,520   

Other Revenue

    118        97        554        285   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenue

  $ 20,231      $ 14,624      $ 62,015      $ 46,088   

Cost of Services

       

Account Costs

  $ 6,428      $ 4,995      $ 21,473      $ 15,389   

Custodial Costs

    938        969        3,487        3,485   

Card Costs

    1,405        974        4,137        2,697   

Other Costs

    1        27        116        397   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Cost of Services

  $ 8,772      $ 6,965      $ 29,213      $ 21,968   
 

 

 

   

 

 

   

 

 

   

 

 

 

Gross Profit

  $ 11,459      $ 7,659      $ 32,802      $ 24,120   

Operating Expenses

       

Sales and Marketing

  $ 2,233      $ 1,745      $ 8,602      $ 7,795   

Technology and Development

    2,186        1,669        7,142        4,229   

General and Administrative

    1,143        910        3,897        3,367   

Amortization of Acquired Intangible Assets

    409        409        1,637        1,637   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Operating Expenses

  $ 5,971      $ 4,733      $ 21,278      $ 17,028   
 

 

 

   

 

 

   

 

 

   

 

 

 

Income from Operations

  $ 5,488      $ 2,926      $ 11,524      $ 7,092   

Other Expense

       

Interest Expense

  $      $ (10   $ (44   $ (326

Loss on Revaluation of Warrants

                  (614     (14

Loss on Revaluation of Redeemable Convertible Preferred Stock Derivative

    (735            (5,363     (103

Other Expense, net

    (92     (73     (129     (147
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Expense

  $ (827   $ (83   $ (6,150   $ (590
 

 

 

   

 

 

   

 

 

   

 

 

 

Income Before Income Taxes

  $ 4,661      $ 2,843      $ 5,374      $ 6,502   

Income Tax Provision (Benefit)

  $ 1,943      $ 1,093      $ 4,141      $ (4,667
 

 

 

   

 

 

   

 

 

   

 

 

 

Net Income and Comprehensive Income

  $ 2,718      $ 1,750      $ 1,233      $ 11,169   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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      Three months ended April 30,      Year ended January 31,  
                     2014                      2013                      2014                     2013  
(in thousands)    (Unaudited)      (Unaudited)                 

Net Income (Loss) per share attributable to common stockholders

          

Basic

   $ 0.52       $ 0.08       $ (1.26   $ 0.81   

Diluted

   $ 0.08       $ 0.04       $ (1.26   $ 0.25   

Shares used in net income (loss) per share calculation

          

Basic

     7,367         5,491         5,651        4,924   

Diluted

     43,736         37,612         5,651        37,514   

 

 

 

      As of April 30,     As of January 31,  
(in thousands)   

2014

    

2013

   

2014

    2013  

Cash and Cash Equivalents

   $ 13,990       $ 6,644      $ 13,917      $ 5,905   

Working Capital(1)

   $ 17,806       $ 8,947      $ 14,327      $ 7,024   

Total Assets

   $ 55,922       $ 46,626      $ 55,090      $ 46,301   

Redeemable Convertible Preferred Stock

   $ 42,693       $ 41,526      $ 46,714      $ 41,186   

Total Stockholders’ Equity (Deficit)

   $ 1,648       $ (4,979   $ (12,706   $ (6,399

 

   

 

 

 

 

(1)   Working capital represents the excess of current assets over current liabilities as follows for the period indicated:

 

(in thousands)    Actual     

Pro forma

(unaudited)

    

Pro forma as
adjusted

(unaudited)

 

 

 

Total current assets

   $ 23,647       $       $         —   

Total current liabilities

     5,841                   
  

 

 

 

Working capital

   $ 17,806       $         —       $   

 

 

The following table represents the number of HSA Members as of April 30, 2014 and 2013 and as of January 31, 2014 and 2013, respectively. See “Management’s discussion and analysis of financial condition and results of operations—Key financial and operating metrics—HSA members” for more information as to how we define HSA Members.

 

      As of April 30,      As of January 31,  
      2014      2013      2014      2013  

HSA Members

     1,008,083         695,109         967,710         677,251   
  

 

 

    

 

 

    

 

 

 

Average HSA Members

     992,225         689,156         747,182         532,053   

 

 

The following table represents AUM as of April 30, 2014 and 2013 and as of January 31, 2014 and 2013, respectively. See “Management’s discussion and analysis of financial condition and results of operations—Key financial and operating metrics—Assets under management” for more information as to how we define AUM.

 

      As of April 30,      As of January 31,  
(in thousands)    2014      2013      $ Change      2014      2013      $ Change  

Cash AUM

   $ 1,488,543       $ 1,105,332       $ 383,211       $ 1,442,336       $ 1,060,696       $ 381,640   

Investment AUM

     212,041         120,741         91,300         182,614         103,335         79,279   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total AUM

   $ 1,700,584       $ 1,226,073       $ 474,511       $ 1,624,950       $ 1,164,031       $ 460,919   
  

 

 

    

 

 

    

 

 

    

 

 

 

Average Daily Cash AUM

   $ 1,459,478       $ 1,086,150       $ 373,328       $ 1,137,825       $ 829,427       $ 308,398   

 

 

 

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Non-GAAP financial measures

We define Adjusted EBITDA, which is a non-GAAP financial metric, as adjusted earnings before interest, taxes, depreciation and amortization and other certain 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 $3.0 million, or 77%, from $3.8 million for the unaudited three months ended April 30, 2013 to $6.8 million for the unaudited three months ended April 30, 2014. Our Adjusted EBITDA increased by $5.3 million, or 50%, from $10.5 million for the year ended January 31, 2013 to $15.8 million for the year ended January 31, 2014.

Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP.

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 April 30,      Year ended January 31,  
(in thousands)                2014                  2013                  2014                  2013  

 

  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income and Comprehensive Income

   $ 2,718       $ 1,750       $ 1,233       $ 11,169   

Interest Expense

             10         44         326   

Income Tax Provision (Benefit)

     1,943         1,093         4,141         (4,667

Depreciation and Amortization

     842         571         2,633         1,728   

Amortization of Acquired Intangible Assets

     409         409         1,637         1,637   

Loss on Revaluation of Warrants

                     614         14   

Loss on Revaluation of Redeemable Convertible Preferred Stock Derivative liability

     735                 5,363         103   

Other (1)

     157         5         104         194   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Adjustments

   $ 4,086       $ 2,088       $ 14,536       $ (665
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted EBITDA

   $ 6,804       $ 3,838       $ 15,769       $ 10,504   

 

  

 

 

    

 

 

    

 

 

    

 

 

 
(1)   For the years ended January 31, 2014 and 2013, respectively, Other consisted of interest income of $(49) and $(7), miscellaneous taxes of $95 and $154, and stock-based compensation of $58 and $47. For the unaudited three months ended April 30, 2014 and 2013, respectively, Other consisted of interest income of $0 and $(12), miscellaneous taxes of $92 and $2, and stock-based compensation of $65 and $15, respectively.

 

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Management’s discussion and analysis of financial condition and results of operations

The following discussion should be read in conjunction with the section entitled “Selected consolidated financial and other data” and our financial statements and related notes thereto included elsewhere in this prospectus. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections entitled “Special note regarding forward-looking statements and industry data” and “Risk factors.” We are not undertaking any obligation to update any forward-looking statements or other statements we may make in the following discussion or elsewhere in this document even though these statements may be affected by events or circumstances occurring after the forward-looking statements or other statements were made. Therefore, no reader of this document should rely on these statements being current as of any time other than the time at which this document is declared effective by the U.S. Securities and Exchange Commission.

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 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. During our years ended January 31, 2014 and 2013, we added approximately 306,000 and 216,000 new HSA Members, respectively. Total HSA Members approximated 968,000 and 677,000 for the years ended January 31, 2014 and 2013, respectively.

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.

 

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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 with our Network Partners that are typically three to five years in duration. We generate custodial fee revenue from interest we earn on cash 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.

From our inception until January 31, 2009, we incurred significant losses, and as of April 30, 2014, our accumulated deficit was $20.6 million. However, we have experienced rapid growth in recent periods. Our total revenue increased from $46.1 million for the year ended January 31, 2013, to $62.0 million for the year ended January 31, 2014. Adjusted EBITDA increased from $10.5 million for the year ended January 31, 2013, to $15.8 million for the year ended January 31, 2014. Total revenue increased from $14.6 million for the unaudited three months ended April 30, 2013, to $20.2 million for the unaudited three months ended April 30, 2014. Adjusted EBITDA increased from $3.8 million for the unaudited three months ended April 30, 2013, to $6.8 million for the unaudited three months ended April 30, 2014. See “Selected consolidated financial and other data—Non-GAAP financial measures.”

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 HSA Plans and other consumer-centric health plans. In particular, we believe that the implementation of the 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 B2B2C distribution strategy, meaning we rely on our Employer Partners and Health Plan Partners to reach potential members to increase the number of 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.

 

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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.

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.

 

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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 HIPAA and the Gramm-Leach-Bliley Act, laws governing the provision of investment advice to consumers, such as 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.

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:

 

      As of April 30,              As of January 31,          
      2014      2013      % Change      2014      2013      % Change  

HSA Members

     1,008,083         695,109         45%         967,710         677,251         43%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average HSA Members

     992,225         689,156         44%         747,182         532,053         40%   

 

 

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 290,000, or 43%, from January 31, 2013 to January 31, 2014. Total HSA members increased by approximately 313,000 from April 30, 2013 to April 30, 2014, or 45%. 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 Assets Under Management as of the periods indicated:

 

     As of April 30,                   As of January 31,                
(in thousands, except
percentages)
  2014     2013     $ Change     % Change     2014     2013     $ Change     % Change  

Cash AUM

  $ 1,488,543      $ 1,105,332      $ 383,211        35%      $ 1,442,336      $ 1,060,696      $ 381,640        36%   

Investment AUM

    212,041        120,741        91,300        76%        182,614        103,335        79,279        77%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total AUM

  $ 1,700,584      $ 1,226,073      $ 474,511        39%      $ 1,624,950      $ 1,164,031      $ 460,919        40%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average Daily Cash AUM

  $ 1,459,478      $ 1,086,150      $ 373,328        34%      $ 1,137,825      $ 829,427      $ 308,398        37%   

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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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 $460.9 million, or 40%, from $1.2 billion at January 31, 2013 to $1.6 billion at January 31, 2014. Our AUM increased by $474.5 million, or 39%, from $1.2 billion at April 30, 2013 to $1.7 billion at April 30, 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. Total AUM per HSA Member was $1,679 and $1,719 as of January 31, 2014 and 2013, respectively.

Adjusted EBITDA

The following table sets forth our Adjusted EBITDA:

 

     Three Months  Ended
April 30,
                  Years Ended
January 31,
               

(in thousands, except

percentages)

  2014     2013     $ Change     % Change     2014     2013     $ Change     % Change  

Adjusted EBITDA

  $ 6,804      $ 3,838      $ 2,966        77%      $ 15,769      $ 10,504      $ 5,265        50%   

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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 $5.3 million, or 50%, from $10.5 million for the year ended January 31, 2013 to $15.8 million for the year ended January 31, 2014. The increase in Adjusted EBITDA was driven by the overall growth of our business, including a $4.4 million, or 62%, increase in income from operations. Our Adjusted EBITDA increased by $3.0 million, or 77%, from $3.8 million for the unaudited three months ended April 30, 2013 to $6.8 million for the unaudited three months ended April 30, 2014. The increase in Adjusted EBITDA was driven by the overall growth of our business, including a $2.6 million, or 88%, increase in income from operations.

Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. See “Selected consolidated financial and other data—Non-GAAP financial measures” for a reconciliation of net income, the most comparable GAAP measure to Adjusted EBITDA.

 

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Key components of our results of operations

Revenue

The following table sets forth our revenue for the periods indicated:

 

     Three Months Ended
April 30,
                  Years Ended
January 31,
               
(in thousands, except
percentages)
  2014     2013     $ Change     % Change     2014     2013     $ Change     % Change  
    (unaudited)     (unaudited)                                      

Account Fee Revenue

  $ 10,388      $ 7,016      $ 3,372        48%      $ 30,575      $ 22,102      $ 8,473        38%   

Custodial Fee Revenue

    5,427        4,449        978        22%        18,955        15,181        3,774        25%   

Card Fee Revenue

    4,298        3,062        1,236        40%        11,931        8,520        3,411        40%   

Other Revenue

    118        97        21        22%        554        285        269        94%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenue

  $ 20,231      $ 14,624      $ 5,607        38%      $ 62,015      $ 46,088      $ 15,927        35%   

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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 RAs 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.

 

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Account costs.    Account costs include the account serving 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.

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

 

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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 following the completion of this offering due to the additional legal, accounting, insurance, investor relations and other costs that we will incur as a 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 unaudited three months ended April 30, 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 will cease to record any related fair value adjustments.

Income tax provision (benefit)

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 April 30, 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 at April 30, 2014.

 

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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 April 30,     Year ended January 31,  
(in thousands)                2014                 2013                 2014                 2013  

 

  

 

 

   

 

 

   

 

 

   

 

 

 
     (unaudited)     (unaudited)              

Revenue

        

Account Fee Revenue

   $ 10,388      $ 7,016      $ 30,575      $ 22,102   

Custodial Fee Revenue

     5,427        4,449        18,955        15,181   

Card Fee Revenue

     4,298        3,062        11,931        8,520   

Other Revenue

     118        97        554        285   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenue

     20,231        14,624        62,015        46,088   

Cost of Services

        

Account Costs

     6,428        4,995        21,473        15,389   

Custodial Costs

     938        969        3,487        3,485   

Card Costs

     1,405        974        4,137        2,697   

Other Costs

     1        27        116        397   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Cost of Services

     8,772        6,965        29,213        21,968   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross Profit

     11,459        7,659        32,802        24,120   

Operating Expenses

        

Sales and Marketing

     2,233        1,745        8,602        7,795   

Technology and Development

     2,186        1,669        7,142        4,229   

General and Administrative

     1,143        910        3,897        3,367   

Amortization of Acquired Intangible Assets

     409        409        1,637        1,637   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Operating Expenses

     5,971        4,733        21,278        17,028   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from Operations

     5,488        2,926        11,524        7,092   

Other Expense

        

Interest Expense

            (10     (44     (326

Loss on Revaluation of Warrants

                   (614     (14

Loss on Revaluation of Redeemable Convertible Preferred Stock Derivative

     (735            (5,363     (103

Other Expense, net

     (92     (73     (129     (147
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Other Expense

     (827     (83     (6,150     (590
  

 

 

   

 

 

   

 

 

   

 

 

 

Income Before Income Taxes

     4,661        2,843        5,374        6,502   

Income Tax Provision (Benefit)

     1,943        1,093        4,141        (4,667
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income and Comprehensive Income

   $ 2,718      $ 1,750      $ 1,233      $ 11,169   

 

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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 April 30,      Year ended January 31,  
    2014     2013                          2014      2013  

 

 

 

 

   

 

 

    

 

 

    

 

 

 
    (unaudited)     (unaudited)                

Revenue

         

Account Fee Revenue

    51%        48%         49%         48%   

Custodial Fee Revenue

    27%        30%         31%         33%   

Card Fee Revenue

    21%        21%         19%         18%   

Other Revenue

    1%        1%         1%         1%   
 

 

 

   

 

 

    

 

 

    

 

 

 

Total Revenue

    100%        100%         100%         100%   

Cost of Services

         

Account Costs

    32%        34%         35%         33%   

Custodial Costs

    4%        7%         5%         8%   

Card Costs

    7%        7%         7%         6%   

Other Costs

    0%        0%         0%         1%   
 

 

 

   

 

 

    

 

 

    

 

 

 

Total Cost of Services

    43%        48%         47%         48%   
 

 

 

   

 

 

    

 

 

    

 

 

 

Gross Profit

    57%        52%         53%         52%   

Operating Expenses

         

Sales and Marketing

    11%        12%         14%         17%   

Technology and Development

    11%        11%         11%         9%   

General and Administrative

    6%        6%         6%         7%   

Amortization of Acquired Intangible Assets

    2%        3%         3%         4%   
 

 

 

   

 

 

    

 

 

    

 

 

 

Total Operating Expenses

    30%        32%         34%         37%   
 

 

 

   

 

 

    

 

 

    

 

 

 

Income from Operations

    27%        20%         19%         15%   

Other Expense

         

Interest Expense

    0%        0%         0%         (1)%   

Loss on Revaluation of Warrants

    0%        0%         (1)%         0%   

Loss on Revaluation of Redeemable Convertible Preferred Stock Derivative

    (4)%        0%         (9)%         0%   

Other Expense, net

    0%        (1)%         0%         0%   
 

 

 

   

 

 

    

 

 

    

 

 

 

Total Other Expense

    (4)%        (1)%         (10)%         (1)%   
 

 

 

   

 

 

    

 

 

    

 

 

 

Income Before Income Taxes

    23%        19%         9%         14%   

Income Tax Provision (Benefit)

    10%        7%         7%         (10)%   
 

 

 

   

 

 

    

 

 

    

 

 

 

Net Income and Comprehensive Income

    13%        12%         2%         24%   

 

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Comparison of the Three Months Ended April 30, 2014 and 2013

Account fee revenue

The $3.4 million increase in account fee revenue for the unaudited three months ended April 30, 2014 as compared to the unaudited three months ended April 30, 2013 was primarily due to an increase in the number of our HSA Members. The number of our HSA Members increased by approximately 313,000, or 45%, from April 30, 2013 to April 30, 2014.

The growth in the number of our HSA Members from April 30, 2013 to April 30, 2014 was due to a combination of growth from new and existing Network Partners.

Custodial fee revenue

The $978,000 increase in custodial fee revenue from the unaudited three months ended April 30, 2013 to the unaudited three months ended April 30, 2014 was due to an increase in average cash AUM of $373 million, or 34%, partially offset by a decrease in the yield on average cash AUM from 1.66% in the unaudited three months ended April 30, 2013 to 1.48% in the unaudited three months ended April 30, 2014. Custodial fees decreased in the unaudited three months ended April 30, 2014 as a percentage of our total revenue compared to the unaudited three months ended April 30, 2013, primarily due to lower-rate custodial depository agreements added in the unaudited three months ended April 30, 2014 to accommodate our growth in cash AUM. This had an adverse impact on our interest yield during unaudited three months ended April 30, 2014 compared to the unaudited three months ended April 30, 2013.

Cash AUM per HSA Member of $1,477 as of April 30, 2014 was 7% lower than the cash AUM per HSA Member of $1,590 as of April 30, 2013. This was primarily due to new HSAs having lower average balances than those HSAs that have been open for multiple years. 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 $1.2 million increase in card fee revenue from the unaudited three months ended April 30, 2013 to the unaudited three months ended April 30, 2014 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.

Other revenue

The $21,000 increase in other revenue from the unaudited three months ended April 30, 2013 to the unaudited three months ended April 30, 2014 was due to an increase in the amount of fees charged to our Network Partners for marketing materials.

 

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Cost of Services

The following table set forth our cost of service for the periods indicated.

 

      Three Months Ended April 30,  
(in thousands, except percentages)    2014      2013      $ Change     % Change  
     (unaudited)      (unaudited)               

Account Costs

   $ 6,428       $ 4,995       $ 1,433        29%   

Custodial Costs

     938         969         (31     -3%   

Card Costs

     1,405         974         431        44%   

Other Costs

     1         27         (26     -96%   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total Cost

   $ 8,772       $ 6,965       $ 1,807        26%   

 

  

 

 

    

 

 

    

 

 

   

 

 

 

Account Costs

The $1.4 million increase in account costs from the unaudited three months ended April 30, 2013 to the unaudited three months ended April 30, 2014 was due to the higher volume of total accounts being serviced. The $1.4 million increase is comprised of $1.1 million related to the hiring of additional personnel to implement and support our new Network Partners and HSA Members. Activation and processing costs increased $409,000 related to account and card activation as well as monthly processing of statements and other communications. These expenses were offset by lower other costs totaling $122,000.

Custodial Costs

Our custodial costs declined $31,000 from the unaudited three months ended April 30, 2013 compared to the unaudited three months ended April 30, 2014. As the macro interest rate environment deteriorated, we lowered the rates we paid to HSA Members. Our custodial costs on average cash AUM decreased from 0.37% in the unaudited three months ended April 30, 2013 to 0.26% for the unaudited three months ended April 30, 2014, while average cash AUM increased from $1.1 billion during the unaudited three months ended April 30, 2013 to $1.5 billion during the unaudited three months ended April 30, 2014.

Card Costs

Card costs increased $431,000, or 44%, during the unaudited three months ended April 30, 2014 compared to the unaudited three months ended April 30, 2013 due to a relatively higher volume of RA spend.

As we continue to add HSAs, our cost of services will increase in dollar amount to support our Network Partners and HSA Members. Cost of services will continue to be affected by a number of different factors. This includes our ability to implement new technology in our Member Education Center as well as scaling our Network Partner implementation and account management functions.

 

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Operating Expenses

The following table sets forth our operating expenses for the periods indicated.

 

      Three Months Ended April 30,     

 

    

 

 
(in thousands, except percentages)    2014      2013      $ Change      % Change  
     (unaudited)      (unaudited)                

Sales and Marketing

   $ 2,233       $ 1,745       $ 488         28%   

Technology and Development

     2,186         1,669         517         31%   

General and Administration

     1,143         910         233         26%   

Amortization of Acquired Intangible Assets

     409         409                 0%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Operating Expenses

   $ 5,971       $ 4,733       $ 1,238         26%   

 

  

 

 

    

 

 

    

 

 

    

 

 

 

Sales and Marketing

The $488,000 increase in sales and marketing expense from the unaudited three months ended April 30, 2013 compared to the unaudited three months ended April 30, 2014 primarily consisted of increased staffing and sales commissions of $468,000, travel and entertainment of $100,000, and other expenses of $36,000. These increases were offset by lower costs in professional fees of $110,000 and information technology of $6,000.

We will continue to invest in sales and marketing by hiring additional personnel and promoting our brand through a variety of marketing and public relations activities. As a result, we expect our sales and marketing expenses to increase in future periods.

Technology and Development

The $517,000 increase in technology and development expenses for the unaudited three months ended April 30, 2014 compared to the unaudited three months ended April 30, 2013 resulted primarily from hiring additional personnel totaling $251,000 and professional fees of $272,000 related to the ongoing project to improve and optimize our proprietary technology platform. There were other expense increases related to stock compensation of $28,000, amortization of $164,000, and other expenses of $82,000 all of which were offset primarily by an increase in capitalized engineering of $280,000.

We will continue to invest in our proprietary technology platform. The timing of development and enhancement projects, including whether they are capitalized or expensed, will significantly affect our technology and development expense both in dollar amount and as a percentage of revenue.

General and Administrative

The $233,000 increase in general and administrative expenses for the unaudited three months ended April 30, 2014 compared to the unaudited three months ended April 30, 2013 was primarily attributable to increased personnel and professional fees of $203,000 and other expenses of $30,000.

As we continue to grow, we expect our general and administrative expenses to continue to increase in dollar amount as we expand general and administrative headcount to support our continued growth.

 

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Amortization of Acquired Intangible Assets

The amortization of acquired intangible assets was unchanged between the unaudited three months ended April 30, 2013 and the unaudited three months ended April 30, 2014 as no additional acquisitions occurred during the year ended January 31, 2014 or during the unaudited three months ended April 30, 2014.

Other expense

The following table sets forth our other expense for the periods indicated.

 

      Three Months Ended April 30,    

 

 
(in thousands)    2014     2013     $ Change  
     (unaudited)     (unaudited)        

Interest Expense

   $      $ (10   $ 10   

Loss on Revaluation of Redeemable Convertible Preferred Stock Derivative

     (735            (735

Other Expense, net

     (92     (73     (19
  

 

 

   

 

 

   

 

 

 

Other Expense

   $ (827   $ (83   $ (744

 

  

 

 

   

 

 

   

 

 

 

Loss on Revaluation of Redeemable Convertible Preferred Stock Derivative

The $735,000 loss during the unaudited three months ended April 30, 2014 relates to a revaluation of the fair market value of our derivative liability associated with our series D-3 redeemable convertible preferred stock. Due to the modification of our series D-3 redeemable convertible preferred stock in March 2014, there will be no further fair market value adjustments.

Income tax provision

Our effective tax rate for the unaudited three months ended April 30, 2014 was 41.7% compared to 38.4% for the unaudited three months ended April 30, 2013. The 3.3 percentage point increase is 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 during the three months ended April 30, 2014 related to an increase in federal and state tax rates.

Comparison of the years ended January 31, 2014 and 2013

Account fee revenue

The $8.5 million increase in account fee revenue from the year ended January 31, 2013 to the year ended January 31, 2014 was primarily due to an increase in the number of our HSA Members. The number of our HSA Members increased by approximately 290,000, or 43%, from the year ended January 31, 2013 to the year ended January 31, 2014.

The growth in the number of our HSA Members from the year ended January 31, 2013 to the year ended January 31, 2014 was due to a combination of organic growth from existing Network Partners, as well as the addition of new HSA Members.

 

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Custodial fee revenue

The $3.8 million increase in custodial fee revenue from the year ended January 31, 2013 to the year ended January 31, 2014 was due to an increase in average cash AUM of 37%, partially offset by a decrease in the yield on average cash AUM from 1.81% for the year ended January 31, 2013 compared to 1.64% for the year ended January 31, 2014. Custodial fees decreased during the year ended January 31, 2014 as a percentage of our total revenue compared to the year ended January 31, 2013, primarily due to lower-rate custodial depository agreements added during the year ended January 31, 2014 to accommodate our growth in cash AUM. This had an adverse impact on our interest yield during the year ended January 31, 2014 compared to the year ended January 31, 2013.

Cash AUM per HSA Member declined from $1,566 at the end of the year ended January 31, 2013 to $1,490 at the end of the year ended January 31, 2014, a decrease of 5%. This was primarily due to new HSAs having lower average balances than those HSAs that have been open for multiple years. 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 $3.4 million increase in card fee revenue from the year ended January 31, 2013 to the year ended January 31, 2014 was due to an overall increase in the number of our HSA Members. 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.

Other revenue

The $269,000 increase in other revenue from the year ended January 31, 2013 to the year ended January 31, 2014 was due to an increase in the amount of fees charged to our Network Partners for marketing materials.

Cost of services

The following table sets forth our cost of services for the periods indicated.

 

      Year ended January 31,                 
(in thousands)    2014      2013      $ Change     % Change  

Account Costs

   $ 21,473       $ 15,389       $ 6,084        40%   

Custodial Costs

         3,487             3,485         2        0%   

Card Costs

     4,137         2,697         1,440        53%   

Other Costs

     116         397         (281     (71)%   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total Cost

   $ 29,213       $ 21,968       $ 7,245        33%   

 

  

 

 

    

 

 

    

 

 

   

 

 

 

Account costs

The $6.1 million increase in account costs from the year ended January 31, 2013 to the year ended January 31, 2014 was due to the higher volume of total accounts being serviced.

Custodial costs

Our custodial costs remained flat from the year ended January 31, 2013 to the year ended January 31, 2014. As the macro interest rate environment deteriorated, we lowered the rates we

 

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paid to individual account holders. Our custodial cost on average cash AUM decreased

from 0.42% during the year ended January 31, 2013 compared to 0.31% during the year ended January 31, 2014, while average cash AUM increased from $829 million during the year ended January 31, 2013 to $1.1 billion during the year ended January 31, 2014.

Card costs

Card costs increased 53% in the year ended January 31, 2014 compared to the year ended January 31, 2013 due to a relatively higher volume of RA spend to total spend.

Operating expenses

The following table sets forth our operating expenses for the periods indicated.

 

     

Year ended January 31,

    

 

    

 

 
(in thousands)    2014      2013      $ Change      % Change  

Sales and Marketing

   $ 8,602       $ 7,795       $ 807         10%   

Technology and Development

     7,142         4,229         2,913         69%   

General and Administration

     3,897         3,367         530         16%   

Amortization of Acquired Intangible Assets

     1,637         1,637                 0%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Operating Expenses

   $ 21,278       $ 17,028       $ 4,250         25%   

 

  

 

 

    

 

 

    

 

 

    

 

 

 

Sales and marketing

The increase in sales and marketing expenses from the year ended January 31, 2013 to the year ended January 31, 2014 was attributable to increased sales commissions of $1.0 million due to higher account growth, offset by reductions in redundant sales resources of $193,000.

Technology and development

The increase in technology and development expenses from the year ended January 31, 2013 to the year ended January 31, 2014 was in part attributable to $704,000 spent on a project to improve and optimize our proprietary technology platform. This included increasing our software development staff and engaging multiple external consultants. Additionally, we increased our spending by $514,000 for our investment service products, by $501,000 on security and compliance, by $465,000 on new product development, and by $323,000 for technical project management. With the increased staffing, we have incurred additional costs of $407,000 related to the purchase of equipment, software development licenses and training.

General and administrative

The increase in general and administrative expenses from the year ended January 31, 2013 to the year ended January 31, 2014 was primarily attributable to increased professional fees.

Amortization of acquired intangible assets

The amortization of acquired intangible assets was unchanged between the year ended January 31, 2013 and the year ended January 31, 2014 as no additional acquisitions occurred during the years ended January 31, 2014 and 2013.

 

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Other expense

The following table sets forth our other expense for the periods indicated.

 

      Year ended
January 31,
   

 

 
(in thousands)    2014     2013     $ Change  

Interest Expense

   $ (44   $ (326   $ 282   

Loss on Revaluation of Warrants

     (614     (14     (600

Loss on Revaluation of Redeemable

      

Convertible Preferred Stock Derivative

     (5,363     (103     (5,260

Other Expense, net

     (129     (147     18   
  

 

 

   

 

 

   

 

 

 

Other Expense

   $ (6,150   $ (590   $ (5,560

 

  

 

 

   

 

 

   

 

 

 

Loss on revaluation of warrants

The $614,000 loss relates to the revaluation of common stock warrants issued in relation to our acquisition of First HSA, LLC in the year ended January 31, 2011.

Loss on revaluation of redeemable convertible preferred stock derivative

The $5.4 million loss during the year ended January 31, 2014 relates to the revaluation of our derivative liability associated with our series D-3 redeemable convertible preferred stock.

Income tax provision (benefit)

The decrease in income tax provision (benefit) from the year ended January 31, 2013 to the year ended January 31, 2014 was primarily attributable to the release of a $7.5 million deferred tax asset valuation allowance in the year ended January 31, 2013 compared to the release of a $29,000 deferred tax asset valuation allowance in the year ended January 31, 2014. During the year ended January 31, 2013, we determined that positive evidence of taxable income coupled with our forecasted profitability outweighed the negative evidence of prior losses resulting in release of the valuation allowance. The additional change was primarily due to an increase in federal income taxes driven by higher taxable income year over year.

 

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Quarterly results of operations

The following table sets forth our unaudited quarterly condensed consolidated statements of operations data for each of the nine quarters ended April 30, 2014. The data has been prepared on the same basis as the audited consolidated financial statements and related notes included in this prospectus and you should read the following tables together with such financial statements. The quarterly results of operations include all normal recurring adjustments necessary for a fair presentation of this data. Results of interim periods are not necessarily indicative of results for the entire year and are not necessarily indicative of future results.

 

    Three Months Ended   
(in thousands,
unaudited)
  April 30,
2014
    January 31,
2014
    October 31,
2013
    July 31,
2013
    April 30,
2013
    January 31,
2013
    October 31,
2012
    July 31,
2012
    April 30,
2012
 

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated Statements of Operations and Comprehensive Income Data:

  

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Revenue

  $ 20,231      $ 17,162      $ 15,248      $ 14,982      $ 14,624      $ 12,356      $ 11,070      $ 11,424      $ 11,238   

Cost of Services

    8,772        8,739        6,870        6,639        6,965        6,450        5,436        5,155        4,927   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross Profit

    11,459        8,423        8,378        8,343        7,659        5,906        5,634        6,269        6,311   

Operating Expenses

    5,971        6,834        4,982        4,730        4,733        5,047        4,077        3,907        3,997   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from Operations

  $ 5,488      $ 1,589      $ 3,396      $ 3,613      $ 2,926      $ 859      $ 1,557      $ 2,362      $ 2,314   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated Statements of Operations Data as a Percentage of Revenue:

  

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Revenue

    100%        100%        100%        100%        100%        100%        100%        100%        100%   

Cost of Services

    43%        51%        45%        44%        48%        52%        49%        45%        44%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross Profit

    57%        49%        55%        56%        52%        48%        51%        55%        56%   

Operating Expenses

    30%        40%        33%        32%        32%        41%        37%        34%        36%   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from Operations

    27%        9%        22%        24%        20%        7%        14%        21%        20%   

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Seasonality

Seasonal concentration of our growth combined with our recurring revenue model create seasonal variation in our results of operations. A significant number of new and existing Network Partners bring new HSA Members beginning in January concurrent with the start of many employers’ benefit plan years. Before we realize any revenue from these new HSA Members we incur costs related to implementing and supporting our new Network Partners and new HSA Members. These costs of services relate to activating the account and the hiring of additional staff, including seasonal help to support our Member Education Center. These expenses begin during the last month of our third fiscal quarter with the majority of expenses incurred in our fourth fiscal quarter. We also experience higher operating expenses in our fourth fiscal quarter due to sales commissions for new accounts activated in January.

Liquidity and capital resources

As of January 31, 2014, our principal source of liquidity was collections from our account, custodial and card fee revenue activities. We rely on cash provided by operating activities to meet our short-term liquidity requirements, which primarily relate to the payment of corporate payroll and other operating costs, and capital expenditures.

At April 30, 2014, cash and cash equivalents totaled $14.0 million.

 

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Capital expenditures for the unaudited three months ended April 30, 2014 were $2.2 million, which was an increase of $1.2 million compared to the unaudited three months ended April 30, 2013. We expect to continue our increased capital expenditures for the remainder of the year ending January 31, 2015 as we are devoting a significant amount of our capital expenditures to improve the architecture and functionality of our proprietary system.

We expect to increase our capital expenditures during the year ending January 31, 2015 compared to the year ended January 31, 2014, particularly in improving the architecture of our proprietary system. Costs to improve the architecture of our proprietary system include outsourced software engineering services, computer hardware, and personnel and related costs for software engineering

With the net proceeds from the offering we plan to pay certain dividends as well as provide for working capital and other general corporate purposes, including to finance our growth, hire additional personnel and fund capital expenditures and potential acquisitions. See “Use of Proceeds.” Potential acquisitions may also be funded from equity and debt financing.

We believe that our existing cash and cash equivalents, anticipated cash flows from operations, and net proceeds from this offering will be sufficient to meet our operating and capital expenditure requirements for at least the next 12 months. To the extent these current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements we may need to raise additional funds through public or private equity or debt financing. We cannot assure you that we will be able to raise additional funds on favorable terms, if at all.

The following table shows our cash flows from operating activities, investing activities and financing activities for the stated periods:

 

      Three Months Ended
April 30,
    Year Ended
January 31,
 
(in thousands)          2014           2013           2014           2013  

 

  

 

 

   

 

 

   

 

 

   

 

 

 
     (unaudited)     (unaudited)              

Net Cash Provided by Operating Activities

   $ 1,463      $ 3,085      $ 18,015      $ 11,770   

Net Cash Used in Investing Activities

     (2,192     (1,010     (4,639     (3,537

Net Cash Provided by (Used in) Financing Activities

     802        (1,335     (5,364     (7,458
  

 

 

   

 

 

   

 

 

   

 

 

 

Increase in Cash and Cash Equivalents

     73        740        8,012        775   

Beginning Cash and Cash Equivalents

     13,917        5,905        5,905        5,130   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending Cash and Cash Equivalents

   $ 13,990      $ 6,645      $ 13,917      $ 5,905   

 

  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows provided by operating activities

Net cash provided by operating activities during the unaudited three months ended April 30, 2014 resulted primarily from our net income of $2.7 million being adjusted for the following non-cash items: depreciation and amortization of $1.3 million, deferred income taxes and taxes payable of $1.8 million, a revaluation of our derivative liability associated with our series D-3 redeemable convertible preferred stock of $735,000 and changes in stock based compensation of $65,000. These items were offset by changes in accrued compensation, accrued liabilities and accounts payable of $4.6 million, as well as accounts receivable of $345,000 and inventories and prepaid items totaling $185,000.

Net cash provided by operating activities during the unaudited three months ended April 30, 2013 resulted primarily from our net income of $1.8 million being adjusted for the following

 

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non-cash items: deferred income taxes of $1.1 million, accrued liabilities of $1.1 million, depreciation and amortization of $980,000, and deferred rent of $189,000. These items were offset by changes in accrued compensation of $1.1 million, accounts receivable of $682,000 and other changes of $272,000.

Net cash provided by operating activities during the year ended January 31, 2014 resulted primarily from our net income of $1.2 million being adjusted for the following non-cash items: depreciation and amortization of $4.3 million, deferred taxes of $3.6 million primarily related to the utilization of net operating losses, or NOLs, generated in prior years, the revaluation of our derivative liability associated with our series D-3 redeemable convertible preferred stock of $5.4 million, as well as the revaluation of our warrant liability of $614,000. Operating cash flow was further increased by changes in accounts payable, accrued compensation and accrued liabilities of $4.6 million, offset by an increase in accounts receivable of $1.5 million, all of which was due to year-over-year growth.

Net cash provided by operating activities during the year ended January 31, 2013 resulted primarily from our net income of $11.2 million being adjusted for the following non-cash items: depreciation and amortization of $3.4 million offset by deferred taxes of $4.9 million, primarily due to the release of the valuation allowance related to previously generated NOLs. Operating cash flow was further increased by changes in accounts payable, accrued compensation and accrued liabilities of $1.2 million, and also a decrease in accounts receivable of $571,000, all of which was due to year-over-year growth.

Cash flows used in investing activities

Net cash used in investing activities for the unaudited three months ended April 30, 2014 was primarily the result of purchases of software and capitalized software development costs of $1.7 million. This compares to $733,000 for the unaudited three months ended April 30, 2013. The increase can be primarily attributed to development of our proprietary system and other software necessary to support our continued account growth. We also increased our purchases of plant, property and equipment from $277,000 during the unaudited three months ended April 30, 2013 to $480,000 during the unaudited three months ended April 30, 2014.

Net cash used in investing activities during both the years ended January 31, 2014 and 2013 were primarily the result of an increase in purchase of software and capitalized software development costs of $3.8 million and $1.9 million, respectively. These increases were due to continued growth. We also increased our purchases of plant, property and equipment by $1.6 million and $831,000, respectively, due to our continued growth. We also issued a note receivable to a stockholder in the principal amount of $800,000 during the year ended January 31, 2013, which was repaid in full during the year ended January 31, 2014.

Cash flows used in financing activities

Cash flow provided by financing activities during the unaudited three months ended April 30, 2014 resulted primarily from the exercising of stock options, warrants and the associated tax benefits.

Cash flow used in financing activities during the unaudited three months ended April 30, 2013 resulted primarily from the repayment of notes in the amount of $1.5 million, partially offset by the exercising of stock options in the amount of $165,000.

Cash flow used in financing activities during the year ended January 31, 2014 resulted primarily from repayment of notes payable of $2.2 million in connection with the prior acquisitions of First

 

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HSA, LLC and First Horizon MSaver, the repurchase of our redeemable convertible preferred stock and convertible preferred stock of $3.4 million, and payment of our cash dividend to holders of our series D-3 redeemable convertible preferred stock of $694,000. This was partially offset by proceeds associated with the exercise of stock options and warrants of $547,000.

Cash flow used in financing activities during the year ended January 31, 2013 resulted primarily from repayment of notes payable of $7.6 million in connection with the prior acquisitions of First HSA, LLC, First Horizon MSaver, and the HSA Member assets of Principal Bank. This was partially offset by $100,000 of proceeds associated with the exercise of stock options.

Contractual obligations

We lease office space, data storage facilities, equipment and certain maintenance requirements under long-term non-cancelable operating leases. Future minimum lease payments required under non-cancelable obligations at January 31, 2014 are as follows:

 

     Payment due by period  
(in thousands)    Less than
1 year
     2-3
years
     3-5
years
     More than
5 years
     Total  

 

  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Office Lease Obligations

   $ 1,021       $ 2,011       $ 2,115       $ 275       $ 5,422   

Data Storage and Equipment Lease Obligations

     126         145                         271   
  

 

 

 
   $ 1,147       $ 2,156       $ 2,115       $ 275       $ 5,693   

 

  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We have entered into a non-cancelable lease agreement with escalating lease payments for office space. The term of the lease began December 1, 2012 and runs for 77 months with renewal options. Under the terms of the agreement, we are responsible for all expenses, taxes, and insurance on the leased property and also a pro rata share of the expenses related to common areas. During the unaudited three months ended April 30, 2014, we amended this lease to add approximately 12,000 square footage. Lease expense for office space for the years ended January 31, 2014 and 2013 totaled $935,000 and $811,000, respectively. We also lease office space in Overland Park, Kansas, which expires in March 2015.

The data storage and equipment leases relate to our offsite data storage facility and office equipment leases. All of these leases expire by the year ended January 31, 2017.

We also have agreements with several entities for access to technology and software. The agreements are based on usage, and there are no minimum required monthly payments.

Processing services agreement

During the year ended January 31, 2012, we amended our merchant processing services agreement with a vendor. The agreement expires in 2016 and requires us to pay a dollar minimum processing fee based on the processing year of the agreement. We may terminate the agreement during the year ended January 31, 2016 by providing 180 days’ written notice.

If we terminate the processing agreement prior to the year ended January 31, 2016, we are required to pay the vendor a termination fee equal to 70% of the aggregate value of the minimum processing fees for the remaining years of the agreement, plus a portion of the account boarding incentive fee.

 

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Minimum processing fees required under the terms of the merchant processing services agreement are as follows:

 

Year Ending January 31, (in thousands)    Minimum
processing fees
 

 

  

 

 

 

2015

   $ 750   

2016

   $ 825   

2017

   $ 825   

 

  

 

 

 

During the years ended January 31, 2014 and 2013, we exceeded the minimum amounts required under the agreement.

Off-balance sheet arrangements

During the unaudited three months ended April 30, 2014 and 2013, and for the years ended January 31, 2014 and 2013, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements.

Critical accounting policies and significant management estimates

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles, or GAAP, in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases, management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. We believe that there are several accounting policies that are critical to understanding our business and prospects for future performance, as these policies affect the reported amounts of revenue and other significant areas that involve management’s judgment and estimates. These significant policies and our procedures related to these policies are described in detail below.

Revenue recognition

We earn revenue primarily from three sources: account fees, custodial fees and card fees. We recognize revenue when the following criteria are met: (1) collectability is reasonably assured; (2) delivery has occurred; (3) persuasive evidence of an arrangement exists; and (4) there is a fixed or determinable fee.

 

 

Account fees:    We charge our Network Partners, employer clients or individual members a monthly account fee once a member account is set up on our system. We recognize revenue on the monthly account fees in the month during which we service each member account.

 

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Custodial fees:    We earn interest on cash AUM. This interest is earned from various FDIC-insured bank partners with whom we deposit our members’ HSA cash assets. We also receive certain administrative and recordkeeping fees for investment AUM from our investment partners. We recognize this revenue in the month in which it is earned.

 

 

Card fees:    We earn card fee (interchange fee) revenue from card transaction “swipes” by our members when our members use our payment cards to pay healthcare-related claims and expenses. We recognize this revenue in the month in which it is earned.

Capitalized software development costs

We account for the costs of computer software developed or obtained for internal use in accordance with Accounting Standards Codification, or ASC, 350-40, “Internal-Use Software.” Costs incurred during operation and post-implementation stages are charged to expense. Costs incurred that are directly attributable to developing or obtaining software for internal use incurred in the application development stage are capitalized. Management’s judgment is required in determining the point when various projects enter the stages at which costs may be capitalized, in assessing the ongoing value of the capitalized costs and in determining the estimated useful lives over which the costs are amortized.

Goodwill and intangible assets

We apply ASC 805, ‘‘Business Combinations,’’ and ASC 350, ‘‘Intangibles—Goodwill and Other’’ to account for goodwill and intangible assets. In accordance with these standards, we amortize all finite lived intangible assets over their respective estimated useful lives, while goodwill has an indefinite life and is not amortized. We review finite lived intangible assets subject to amortization for impairment whenever events or circumstances indicate that the associated carrying amount may not be recoverable. Goodwill is not amortized but is tested for impairment at least annually or more frequently whenever a triggering event or change in circumstances occurs, at the reporting unit level. We are required to recognize an impairment charge if the carrying amount of the reporting unit exceeds its fair value.

Management uses all available information to make this fair value determination, including the present values of expected future cash flows using discount rates commensurate with the risks involved in the assets and observed market multiples of operating cash flows and net income. In addition, if the estimated fair value of the reporting unit is less than the book value (including the goodwill), further management judgment must be applied in determining the fair values of individual assets and liabilities for purposes of the hypothetical purchase price allocation. No provision for goodwill or other intangible asset impairments was recorded during the three months ended April 30, 2014, or the years ended January 31, 2014 and 2013. However, a lower fair value estimate in the future could result in impairment. After this offering, our stock price and associated market capitalization will also be considered in the determination of reporting unit fair value. A prolonged or significant decline in our unit price could provide evidence of a need to record a material impairment of goodwill.

Income taxes

We account for income taxes and the related accounts under the liability method as set forth in the authoritative guidance for accounting for income taxes. Under this method, current tax liabilities and assets are recognized for the estimated taxes payable or refundable on the tax

 

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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, for net operating losses, and for 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

A valuation allowance is provided for when it is more likely than not that some or all of the deferred tax assets may not be realized in future years. We recognize the tax benefit from an uncertain tax position taken or expected to be taken in a tax return using a two-step approach. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that the tax position will be sustained upon examination by the relevant taxing authorities, based on the technical merits of the position. For tax positions that are more likely than not to be sustained upon audit, the second step is to measure the tax benefit in the financial statements as the largest benefit that has a greater than 50% likelihood of being sustained upon settlement. We recognize interest and penalties, if any, related to unrecognized tax benefits as a component of other income (expense) in the Statements of Operations and Comprehensive Income. Significant judgment is required to evaluate uncertain tax positions. Changes in facts and circumstances could have a material impact on our effective tax rate and results of operations.

Stock-based compensation

Stock-based compensation costs related to stock options granted to employees are measured at the date of grant based on the estimated fair value of the award, net of estimated forfeitures. We estimate the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option-pricing model. The grant date fair value of stock-based awards is recognized on a straight-line basis over the requisite service period, which is generally the vesting period of the award. Stock options we grant to employees generally vest over four years. We recorded stock-based compensation expense of $65,000, $15,000, $57,000 and $48,000 for the unaudited three months ended April 30, 2014 and 2013, and for the years ended January 31, 2014 and 2013, respectively. As of April 30, 2014, we had $235,000 of total unrecognized stock-based compensation expense, net of estimated forfeitures, related to stock option grants that will be recognized over a weighted-average period of 1.8 years. We expect to continue to grant stock options in the future, and to the extent that we do, our stock-based compensation expense recognized in future periods will likely increase.

We have granted performance-based options to certain employees that generally vest upon the satisfaction of a liquidity condition or achievement of financial metrics. Because the liquidity condition has not been met until the occurrence of a qualifying liquidity event (a qualified initial public offering) and the achievement of financial metrics were not met as of the end of fiscal year 2014, we have not recorded any expense to date relating to our performance-based option grants. The company expects to achieve the financial metrics for such performance-based options during the first half of fiscal year 2015 and will report such related expense. In connection with this offering, we will record stock-based compensation expense based on the grant date fair value at such date.

 

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The Black-Scholes option-pricing model requires the use of highly subjective assumptions to estimate the fair value of stock-based awards. If we had made different assumptions, our stock-based compensation expense, net income and net income per share of common stock could have been significantly different. These assumptions include:

 

 

Fair value of our common stock:    Because our stock was not publicly traded prior to our initial public offering, we estimate the fair value of our common stock. See “—Significant factors, assumptions and methodologies used in determining fair value of our common stock” below. Upon the completion of our initial public offering, our common stock will be valued by reference to the publicly-traded price of our common stock.

 

 

Expected volatility:    As we do not have a trading history for our common stock, the expected stock price volatility for our common stock was estimated by taking the average historical price volatility for industry peers based on daily price observations over a period equivalent to the expected term of the stock option grants. We did not rely on implied volatilities of traded options in our industry peers’ common stock because the volume of activity was relatively low. We intend to continue to consistently apply this process using the same or similar public companies until a sufficient amount of historical information regarding the volatility of our own common stock price becomes available, or unless circumstances change such that the identified companies are no longer similar to us, in which case, more suitable companies whose share prices are publicly available would be utilized in the calculation.

 

 

Expected term:    The expected term represents the period that our stock-based awards are expected to be outstanding. Expected term is derived from our historical data on employee exercises and post-vesting employment termination behavior taking into account the contractual life of the award.

 

 

Risk-free interest rate:    The risk-free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the expected term of the options for each option group.

 

 

Expected dividend yield:    We have never declared or paid any cash dividends to our common stockholders and do not presently plan to pay any cash dividends in the foreseeable future, other than in connection with the special dividend described in “Use of proceeds.” Consequently, we used an expected dividend yield of zero.

The following table presents the weighted-average assumptions used to estimate the fair value of options granted during the periods presented:

 

      Year Ended
January 31,
 
            2014            2013  
               

Expected volatility

     32.9%         31.3%   

Expected term (in years)

     3         3   

Risk-free interest rate

     0.35%-0.80%         0.31%-0.39%   

Expected dividend yield

     —%         —%   

 

  

 

 

    

 

 

 

We will continue to use judgment in evaluating the assumptions utilized for our stock-based compensation expense calculations on a prospective basis.

In addition to the assumptions used in the Black-Scholes option-pricing model, the amount of stock-based compensation expense we recognize in our financial statements includes an estimate

 

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of stock option forfeitures. We estimate our forfeiture rate based on an analysis of our actual forfeitures and will continue to evaluate the appropriateness of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover and other factors. Changes in the estimated forfeiture rate can have a significant impact on our stock-based compensation expense as the cumulative effect of adjusting the rate is recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the stock-based compensation expense recognized in the financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the stock-based compensation expense recognized in our financial statements.

Significant factors, assumptions and methodologies used in determining fair value of our common stock

The valuation of our common stock was performed in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. In order to value our common stock, we first determined our business enterprise value and then allocated this business enterprise value to our common stock and common stock equivalents. Our business enterprise value was estimated using a combination of two generally accepted approaches: the income approach and the market-based approach. The income approach estimates enterprise value based on the estimated present value of future net cash flows the business is expected to generate over its remaining life. The estimated present value is calculated using a discount rate reflective of the cost of capital associated with an investment in a similar company and risks associated with our cash flow projections. Our discounted cash flow projections are sensitive to highly subjective assumptions that we were required to make each valuation date. The market-based approach measures the value of a business through an analysis of recent sales or offerings of comparable investments or assets, and in our case, focuses on comparing us to the group of peer companies. In applying this method, valuation multiples are derived from historical operating data of the peer company group. We then apply multiples to our operating data to arrive at a range of indicated values of the company. For each valuation, we prepared a financial forecast to be used in the computation of the value of invested capital for both the market approach and income approach. The financial forecasts took into account our past results and expected future financial performance. As an additional indicator of fair value, we considered an arm’s-length transaction involving the potential sale and purchase of our capital stock by an unsolicited investor occurring near the respective valuation dates. There is inherent uncertainty in these estimates as the assumptions used are highly subjective and subject to changes as a result of new operating data and economic and other conditions that impact our business.

Because there has been no public market for our common stock, the fair value of the common stock that underlies our stock options has historically been determined by our board of directors based upon information available to it at the time of grant including the following:

 

 

contemporaneous valuations performed by independent third-party specialists;

 

 

our operating and financial performance, including our levels of available capital resources;

 

 

our stage of development;

 

 

current business conditions and projections;

 

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trends and developments in our industry;

 

 

the valuation of publicly traded companies in our sector, as well as recently completed mergers and acquisitions of peer companies;

 

 

rights, preferences and privileges of our common stock compared to the rights, preferences and privileges of our other outstanding equity securities;

 

 

equity market conditions affecting comparable public companies, as reflected in comparable companies’ market multiples, initial public offering valuations and other metrics;

 

 

U.S. and global economic and capital market conditions;

 

 

the likelihood of achieving a liquidity event for the shares of common stock, such as an initial public offering or an acquisition of our company given prevailing market and sector conditions;

 

 

the illiquidity of our securities by virtue of being a private company;

 

 

business risks; and

 

 

management and board experience.

There is inherent uncertainty in these estimates and if we had made different assumptions than those used, the amount of our stock-based compensation expense, net income and net income per share amounts could have been significantly different. Following the closing of this offering, the fair value per share of our common stock for purposes of determining stock-based compensation expense will be the closing price of our common stock as reported on              on the applicable grant date.

Based on an assumed initial public offering price of $         per share, the intrinsic value of stock options outstanding as of                 , 2014 was $         million, of which $         million and $         million related to stock options that were vested and unvested, respectively, at that date.

Estimated fair value of common stock warrant liability and redeemable convertible preferred stock derivative liability

We account for certain common stock warrants as freestanding instruments. These warrants are classified as liabilities on our balance sheets and are recorded at their estimated fair value. At the end of each reporting period, changes in estimated fair value during the period are recorded as a component of other expense. We will continue to adjust these liabilities for changes in fair value until the earlier of the expiration of the warrants, exercise of the warrants, or conversion of the preferred stock underlying the warrants into common stock upon the completion of a liquidity event, including an initial public offering, at which time the liabilities will be reclassified to additional paid in capital.

We estimate the fair values of our common stock liability classified warrants using an option pricing model based on inputs as of the valuation measurement dates, including the fair value of our common stock, the estimated volatility of the price of our convertible and redeemable convertible preferred stock, the expected term of the warrants and the risk-free interest rates.

We previously accounted for the conversion feature in our series D-3 redeemable convertible preferred stock as a derivative liability. Prior to March, 31, 2014, the series D-3 redeemable

 

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convertible preferred stock may have been redeemed at any time following August 11, 2018, for a per share amount equal to the greater of the fair market 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. Exercise of the redemption feature would allowed the holder to receive the fair value of the conversion feature in cash and therefore the conversion feature provides for net settlement. As the series D-3 redeemable convertible preferred stock was determined to be a debt host, the conversion feature was not clearly and closely related to the debt host contract. Accordingly, the conversion feature required bifurcation and separate accounting. At the end of each reporting period, changes in estimated fair value during the period were recorded as a component of other expense.

We estimate the fair values of our derivative liability associated with our series D-3 redeemable convertible preferred stock using an option pricing model based on inputs as of the valuation measurement dates, including the fair value of our common stock, the estimated volatility of the price of our convertible preferred stock, the expected term of the warrants and the risk-free interest rates.

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 we modified the terms of our series D-3 redeemable convertible preferred stock. As a result of the modifications, 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 subsequent to March 31, 2014.

Internal control over financial reporting

In connection with our preparation for this offering, we concluded that there was a material weakness in our internal control over financial reporting that caused the restatement of our previously issued financial statements as of and for the year ended January 31, 2013. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.

The material weakness we identified comprised a lack of sufficient expertise to appropriately address and timely account for complex, non-routine transactions in accordance with U.S. generally accepted accounting principles. The evidence of this material weakness related primarily to the measurement and classification of redeemable convertible preferred stock and warrants issued in connection with the redeemable convertible preferred stock.

During the year ended January 31, 2014 and in preparation for this offering, we executed a remediation plan that included the hiring of additional resources to build our financial management and reporting infrastructure and to further develop our accounting policies and financial reporting procedures. While we believe we have taken actions to remediate this material weakness, the actions that we have taken are subject to continued review, supported by confirmation and testing by management, as well as audit committee oversight. As such, while we believe that the steps we have taken have remediated this material weakness, for the reasons stated above, we cannot assure you that we have remediated this material weakness or that we will not in the future have additional material weaknesses.

 

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For additional information about this material weakness, see “Risk factors—Risks related to this offering and owning our common stock—We have identified a material weakness in our financial reporting and may identify additional material weaknesses in the future that may cause us to fail to meet our reporting obligations or result in material misstatements of our financial statements. If we have failed to remediate our material weakness or if we fail to maintain effective control over financial reporting, our ability to accurately and timely report our financial results could be adversely affected.”

Qualitative and quantitative disclosures about market risk

Concentration of market risk

We derive a substantial portion of our revenue from providing services to tax-advantaged healthcare account holders. A significant downturn in this market or changes in state and/or federal laws impacting the preferential tax treatment of healthcare accounts such as HSAs could have a material adverse effect on our results of operations. During the unaudited three months ended April 30, 2014, and for the years ended January 31, 2014 and 2013, no one customer accounted for greater than 5% of our total revenue.

Concentration of credit risk

Financial instruments, which potentially subject us to concentrations of credit risk, consist primarily of cash. We maintain our cash and cash equivalents in bank and other depository accounts, which, at times, may exceed federally insured limits. Our cash and cash equivalents held in banks at April 30, 2014 were $14.0 million, of which $250,000 was covered by federal depository insurance. We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk with respect to our cash. Our accounts receivable balance at April 30, 2014 was $6.0 million. We have not experienced any significant write-offs to our accounts receivable and believe that we are not exposed to significant credit risk with respect to our accounts receivable.

Interest rate risk

We have entered into depository agreements with financial institutions for our cash AUM. The contracted interest rates were negotiated at the time the depository agreements were executed. A significant reduction in prevailing interest rates may make it difficult for us to continue to place custodial deposits at the current contracted rates.

 

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Business