HEALTHEQUITY, INC. 10-Q

Item 2. Management’s discussion and analysis of financial condition and results of operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Statements that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would” and similar expressions or variations intended to identify forward-looking statements. Such statements include, but are not limited to, statements concerning the impact of the ongoing COVID-19 pandemic on the Company, the anticipated synergies and other benefits of the acquisition of WageWorks, health savings accounts and other tax-advantaged consumer-directed benefits, tax and other regulatory changes, market opportunity, our future financial and operating results, our investment and acquisition strategy, our sales and marketing strategy, management’s plans, beliefs and objectives for future operations, technology and development, economic and industry trends or trend analysis, expectations about seasonality, opportunity for portfolio purchases and other acquisitions, operating expenses, anticipated income tax rates, capital expenditures, cash flows and liquidity. These statements are based on the beliefs and assumptions of our management based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk factors” included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2020, this Quarterly Report on Form 10-Q, and our other reports filed with the SEC. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such events. Overview We are a leader and an innovator in providing technology-enabled services platforms that empower consumers to make healthcare saving and spending decisions. Consumers and employers use our platforms to manage tax-advantaged health savings accounts ("HSAs") and other consumer-directed benefits ("CDBs") offered by employers, including flexible spending accounts and health reimbursement arrangements (“FSAs” and “HRAs”), Consolidated Omnibus Budget Reconciliation Act (“COBRA”) administration, commuter and other benefits, compare treatment options and pricing, evaluate and pay healthcare bills, receive personalized benefit information, access remote and telemedicine benefits, earn wellness incentives, and receive investment advice to grow their tax-advantaged healthcare savings. The core of our offerings is the HSA, a financial account through which consumers spend and save long-term for healthcare expenses on a tax-advantaged basis. As of October 31, 2020, we administered 5.5 million HSAs, with balances totaling $12.4 billion, which we call HSA Assets. Also, as of October 31, 2020, we administered 7.0 million complementary CDBs. We refer to the aggregate number of HSAs and other CDBs on our platforms as Total Accounts, of which we had 12.5 million as of October 31, 2020. We reach consumers primarily through relationships with their employers, which we call Clients. We reach Clients primarily through a sales force that calls on Clients directly, relationships with benefits brokers and advisors, and integrated partnerships with a network of health plans, benefits administrators, benefits brokers and consultants, and retirement plan recordkeepers, which we call Network Partners. We have grown our share of the growing HSA market from 4% in calendar year 2010 to 16% in 2020, including by 2% as a result of the acquisition (the "Acquisition") of WageWorks, Inc. ("WageWorks") on August 30, 2019. According to Devenir, today we are the largest HSA provider by accounts and second largest by assets. In addition, we believe we are the largest provider of other CDBs. We seek to differentiate ourselves through our proprietary technology, product breadth, ecosystem connectivity, and service-driven culture. Our proprietary technology is designed to help consumers optimize the value of their HSAs and other CDBs, as they gain confidence and skill in their management of financial responsibility for lifetime healthcare. -18- Table of Contents Our ability to engage consumers is enhanced by our platforms' capacity to securely share data in both directions with others in the health, benefits, and retirement ecosystems, which we call Ecosystem Partners. Our commuter benefits offering also leverages connectivity to an ecosystem of mass transit, ride hailing, and parking providers. These strengths reflect our “DEEP Purple” culture of remarkable service to customers and teammates, achieved by driving excellence, ethics, and process into everything we do. We earn revenue primarily from three sources: service, custodial, and interchange. We earn service revenue mainly from fees paid by Clients on a recurring per-account per-month basis. We earn custodial revenue mainly from HSA Assets held at our members’ direction in federally insured cash deposits, insurance contracts or mutual funds, and from investment of Client-held funds. We earn interchange revenue mainly from fees paid by merchants on payments that our members make using our physical payment cards and virtual platforms. See “Key components of our results of operations” for additional information on our sources of revenue, including regarding the adverse impacts caused by the ongoing COVID-19 pandemic. Acquisition of WageWorks On August 30, 2019, we completed the Acquisition of WageWorks and paid approximately $2.0 billion in cash to WageWorks stockholders, financed through net borrowings of approximately $1.22 billion under a new term loan facility and approximately $816.9 million of cash on hand. We expect the Acquisition to enable us to increase the number of our employer sales opportunities, the conversion of these opportunities to Clients, and the value of Clients in generating members, HSA Assets and complementary CDBs. WageWorks’ historic strength of selling to employers directly and through health benefits brokers and advisors complements our distribution through health plans, benefit administrators and retirement record-keeping partners. With WageWorks’ CDB capabilities, we are working to provide employers with a single partner for both HSAs and other CDBs, which is preferred by the vast majority of employers according to research conducted for us by Aite Group. For Clients that partner with us in this way, we believe we can produce more value by encouraging both CDB participants to contribute to HSAs and HSA-only members to take advantage of tax savings available through other CDBs. Accordingly, we believe that there are significant opportunities to expand the scope of services that we provide to our Clients. The Acquisition has significantly increased the number of our Total Accounts, HSA Assets, Client-held funds, Adjusted EBITDA, total revenue, total cost of revenue, operating expenses, and other financial results. These increases impact the comparability of the period-over-period results described in this report. Key factors affecting our performance We believe that our future performance will be 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 also "Results of Operations - Revenue" for information relating to the ongoing COVID-19 pandemic and also the section entitled “Risk factors” included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2020, this Quarterly Report on Form 10-Q and our other reports filed with the SEC. WageWorks integration On August 30, 2019, we completed the Acquisition of WageWorks. We are continuing our multi-year integration effort that we expect will produce long-term cost savings and revenue synergies. We have identified opportunities of approximately $80 million in annualized ongoing net synergies to be achieved by the end of the fiscal year ending January 31, 2022, of which approximately $55 million have been achieved as of October 31, 2020. Furthermore, we anticipate generating additional revenue synergies over the longer-term as our combined distribution channels and existing client base take advantage of the broader platform and service offerings and as we continue to drive member engagement. We estimate non-recurring costs to achieve these synergies of approximately $100 million realized within 24 to 36 months of the closing of the Acquisition, resulting from investment in technology platforms, back-office systems and platform integration, as well as rationalization of cost of operations. As of October 31, 2020, we had incurred a total of approximately $63 million of non-recurring merger integration costs related to the Acquisition. Structural change in U.S. health insurance We derive revenue primarily from healthcare-related saving and spending by consumers in the U.S., which are driven by changes in the broader healthcare industry, including the structure of health insurance. The average premium for employer-sponsored health insurance has risen by 22% since 2015 and 55% since 2010, resulting in increased participation in HSA-qualified health plans and HSAs and increased consumer cost-sharing in health -19- Table of Contents insurance more generally. We believe that continued growth in healthcare costs and related factors will spur continued growth in HSA-qualified health plans and HSAs and may encourage policy changes making HSAs or similar vehicles available to new populations such as individuals in Medicare. However, the timing and impact of these and other developments in U.S. healthcare are uncertain. Moreover, changes in healthcare policy, such as "Medicare for all" plans, could materially and adversely affect our business in ways that are difficult to predict. Trends in U.S. tax law Tax law has a profound impact on our business. Our offerings to members, Clients, and Network Partners consist primarily of services enabled, mandated, or advantaged by provisions of U.S. tax law and regulations. We believe that the present direction of U.S. tax policy is favorable to our business, as evidenced for example by recent regulatory action and bipartisan policy proposals to expand the availability of HSAs. However, changes in tax policy are speculative, and may affect our business in ways that are difficult to predict. Our client base Our business model is based on a B2B2C distribution strategy, meaning that we attract Clients and Network Partners to reach consumers to increase the number of our members with HSA accounts and complementary CDBs. We believe that there are significant opportunities to expand the scope of services that we provide to our current Clients. Broad distribution footprint We believe we have a diverse distribution footprint to attract new Clients and Network Partners. Our sales force calls on enterprise and regional employers in industries across the U.S., as well as potential Network Partners from among health plans, benefits administrators, and retirement plan record keepers. Product breadth We are the largest custodian and administrator of HSAs (by number of accounts), as well as a market-share leader in each of the major categories of complementary CDBs, including FSAs and HRAs, COBRA and commuter benefits administration. Our Clients and their benefits advisors increasingly seek HSA providers that can deliver an integrated offering of HSAs and complementary CDBs. With our CDB capabilities, we can provide employers with a single partner for both HSAs and complementary CDBs, which is preferred by the vast majority of employers, according to research conducted for us by Aite Group. We believe that the combination of HSA and complementary CDB offerings significantly strengthens our value proposition to employers, health benefits brokers and consultants, and Network Partners as a leading single-source provider. Our proprietary technology platforms We believe that innovations incorporated in our technology that enable consumers to make healthcare saving and spending decisions and maximize the value of their tax-advantaged benefits differentiate us from our competitors and drive our growth. We are building on these innovations by combining our HSA platform with WageWorks' complementary CDB offerings, giving us a full suite of CDB products, and adding to our solutions set and leadership position within the HSA sector. We intend to continue to invest in our technology development to enhance our platforms' capabilities and infrastructure, while maintaining a focus on data security and the privacy of our customers' data. For example, we are making significant investments in our platforms' architecture and related platform infrastructure to improve our transaction processing capabilities and support continued account and transaction growth, as well as in data-driven personalized engagement to help our members spend less, save more, and build wealth for retirement. Our “DEEP Purple” service culture The successful healthcare consumer needs education and guidance delivered by people as well as technology. We believe that our "DEEP Purple" culture, which we define as Driving Excellence, Ethics, and Process while providing remarkable service, is a significant factor in our ability to attract and retain customers and to address nimbly, opportunities in the rapidly changing healthcare sector. We make significant efforts to promote and foster DEEP 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. Interest rates As a non-bank custodian, we contract with federally insured banks, credit unions, and insurance company partners, which we collectively call our Depository Partners, to hold custodial cash assets on behalf of our members. We earn a material portion of our total revenue from interest paid to us by these partners. The lengths of our agreements with Depository Partners typically range from three to five years and may have fixed or variable interest -20- Table of Contents rate terms. The terms of new and renewing agreements may be impacted by the then-prevailing interest rate environment, which in turn is driven by macroeconomic factors and government policies over which we have no control. Such factors, and the response of our competitors to them, also determine the amount of interest retained by our members. We believe that diversification of Depository Partners, varied contract terms and other factors reduce our exposure to short-term fluctuations in prevailing interest rates and mitigate the short-term impact of sustained increases or declines in prevailing interest rates on our custodial revenue. Over longer periods, sustained shifts in prevailing interest rates affect the amount of custodial revenue we can realize on custodial assets and the interest retained by our members. We expect our custodial revenue to continue to be adversely affected by the interest rate cuts by the Federal Reserve associated with the ongoing COVID-19 pandemic and other market conditions that have caused interest rates to decline significantly and, as a result, funds that we place with our Depository Partners in this environment will receive lower interest rates than we originally expected. Interest on our long-term debt changes frequently due to variable interest rate terms, and as a result, our interest expense is expected to fluctuate based on changes in prevailing interest rates. Our competition and industry Our direct competitors are HSA custodians and other CDB providers. Many of these are 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 platforms and capabilities to increase our market share. However, some of our direct competitors (including well-known mutual fund companies such as Fidelity Investments and healthcare service companies such as United Health Group's Optum) 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 Network Partners may also choose to offer competitive 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. As a result of the outbreak of the COVID-19 virus, we have seen an adverse impact on sales opportunities, with some opportunities delayed and most now being held virtually. As an increasing number of companies go out of business, the number of our Clients and potential Clients is adversely affected. Increased unemployment may mean that fewer of our members contribute to HSAs, FSAs or other CDBs. We have seen a significant decline in the use of commuter benefits due to many of our members working from home during the outbreak or other impacts from the outbreak, which has negatively impacted both our interchange revenue and service revenue, and this "work from home" trend may continue after the pandemic. We have also seen a decline in interchange revenue across all other products. The extent to which the COVID-19 virus will negatively impact our business is highly uncertain and cannot be accurately predicted. Regulatory environment Federal law and regulations, including the Affordable Care Act, the Internal Revenue Code, the Employee Retirement Income Security Act and Department of Labor regulations, and public health regulations that govern the provision of health insurance and provide the tax advantages associated with our products, play a pivotal role in determining our market opportunity. Privacy and data security-related laws such as the Health Insurance Portability and Accountability Act, or HIPAA, and the Gramm-Leach-Bliley Act, laws governing the provision of investment advice to consumers, such as the Investment Advisers Act of 1940, or the Advisers Act, the USA PATRIOT Act, anti-money laundering laws, 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. For example, our subsidiary HealthEquity Trust Company is regulated by the Wyoming Division of Banking, and several states are considering, or have already passed, new privacy regulations that can affect our business. Various states also have laws and regulations that impose additional restrictions on our collection, storage, and use of personally identifiable information. Privacy regulation in particular has become a priority issue in many states, including California, which in 2018 enacted the California Consumer Privacy Act broadly regulating California residents’ personal information and providing California residents with various rights to access and control their data, and the new California Privacy Rights Act. We have also seen an increase in regulatory changes related to our products due to government responses to the COVID-19 pandemic and may continue to see additional regulatory changes. 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. -21- Table of Contents Our acquisition strategy In addition to the WageWorks acquisition, we have a successful history of acquiring HSA portfolios from competitors who have chosen to exit the industry and complementary assets and businesses that strengthen our platform. We seek to continue this growth strategy and are regularly engaged in evaluating different opportunities. We have developed an internal capability to source, evaluate, and integrate acquired HSA portfolios. We intend to continue to thoughtfully pursue acquisitions of complementary assets and businesses that we believe will strengthen our platform. 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. Total Accounts The following table sets forth our HSAs, CDBs, and Total Accounts as of and for the periods indicated: (in thousands, except percentages) October 31, 2020 October 31, 2019 % Change January 31, 2020 HSAs 5,460 5,031 9 % 5,344 New HSAs from Sales - Quarter-to-date 104 129 (19) % 379 New HSAs from Sales - Year-to-date 317 344 (8) % 724 New HSAs from Acquisitions - Year-to-date — 757 (100) % 757 HSAs with investments 302 197 54 % 220 CDBs 7,060 7,504 (6) % 7,437 Total Accounts 12,520 12,535 0 % 12,781 Average Total Accounts - Quarter-to-date 12,084 9,970 21 % 12,603 Average Total Accounts - Year-to-date 12,429 6,482 92 % 8,013 The number of our HSAs and CDBs are key metrics because our revenue is driven by the amount we earn from them. The number of our HSAs increased by approximately 0.4 million, or 9%, from October 31, 2019 to October 31, 2020, due to further penetration into existing Network Partners and the addition of new Network Partners. The number of our CDBs decreased by approximately 0.4 million, or 6%, from October 31, 2019 to October 31, 2020, driven primarily by a decrease in commuter benefit accounts resulting from the impact of the COVID-19 pandemic and associated local governmental restrictions around the country. HSAs are individually owned portable healthcare accounts. As HSA members transition between employers or health plans, they may no longer be enrolled in a high deductible health plan that qualifies them to continue to make contributions to their HSA. HSA Assets The following table sets forth our HSA Assets as of and for the periods indicated: (in millions, except percentages) October 31, 2020 October 31, 2019 % Change January 31, 2020 HSA cash with yield (1) $ 8,759 $ 7,564 16 % $ 8,301 HSA cash without yield (2) 258 381 (32) % 383 Total HSA cash 9,017 7,945 13 % 8,684 HSA investments with yield (1) 3,255 2,188 49 % 2,495 HSA investments without yield (2) 168 326 (48) % 362 Total HSA investments 3,423 2,514 36 % 2,857 Total HSA Assets 12,440 10,459 19 % 11,541 Average daily HSA cash with yield - Year-to-date 8,445 6,652 27 % 6,937 Average daily HSA cash with yield - Quarter-to-date $ 8,672 $ 7,146 21 % $ 7,791 (1) HSA Assets that generate custodial revenue. (2) HSA Assets that do not generate custodial revenue. -22- Table of Contents Our HSA Assets, which are our HSA members' assets for which we are the custodian or administrator, or from which we generate custodial revenue, consist of the following components: (i) cash deposits, which are deposits with our Depository Partners or other custodians, (ii) custodial cash deposits invested in annuity contracts with our insurance company partners, and (iii) investments in mutual funds through our custodial investment fund partners. We are continuing to transition HSA cash without yield to HSA cash with yield and expect to complete the transition in fiscal 2022. Measuring our HSA Assets is important because our custodial revenue is directly affected by average daily custodial balances for HSA Assets that are revenue generating. Our total HSA Assets increased by $2.0 billion, or 19%, from October 31, 2019 to October 31, 2020, due primarily to HSA contributions, decreased spending per HSA, and appreciation of invested balances. Total HSA cash increased by $1.1 billion, or 13%, from October 31, 2019 to October 31, 2020, due primarily to HSA contributions and decreased spending per HSA. Our HSA investment assets increased by $0.9 billion, or 36%, from October 31, 2019 to October 31, 2020, reflecting our strategy of helping our HSA members build wealth and invest for retirement. Client-held funds (in millions, except percentages) October 31, 2020 October 31, 2019 % Change January 31, 2020 Client-held funds (1) $ 798 $ 670 19 % $ 779 Average daily Client-held funds - Year-to-date (1) 847 268 216 % 382 Average daily Client-held funds - Quarter-to-date (1) 819 500 64 % 727 (1) Client-held funds that generate custodial revenue. Our Client-held funds are interest-earning deposits from which we generate custodial revenue. These deposits are amounts remitted by Clients and held by us on their behalf to pre-fund and facilitate administration of CDBs. We deposit the Client-held funds with our Depository Partners in interest-bearing, demand deposit accounts that have a floating interest rate and no set term or duration. Client-held funds fluctuate depending on the timing of funding and spending of CDB balances. Adjusted EBITDA We define Adjusted EBITDA, which is a non-GAAP financial metric, as adjusted earnings before interest, taxes, depreciation and amortization, amortization of acquired intangible assets, stock-based compensation expense, merger integration expenses, acquisition costs, gains and losses on marketable equity securities, and certain other non-operating items. We believe that Adjusted EBITDA provides useful information to investors and analysts in understanding and evaluating our operating results in the same manner as our management and our board of directors because it reflects operating profitability before consideration of non-operating expenses and non-cash expenses, and serves as a basis for comparison against other companies in our industry. -23- Table of Contents The following table presents a reconciliation of net income (loss), the most comparable GAAP financial measure, to Adjusted EBITDA for the periods indicated: Three months ended October 31, Nine months ended October 31, (in thousands) 2020 2019 2020 2019 Net income (loss) $ 1,789 $ (21,334) $ 3,467 $ 39,854 Interest income (174) (2,046) (850) (5,273) Interest expense 6,952 10,225 28,110 10,355 Income tax provision (benefit) 2,340 (9,918) 2,015 3,908 Depreciation and amortization 10,253 6,203 28,580 12,940 Amortization of acquired intangible assets 19,126 13,051 56,905 16,036 Stock-based compensation expense 11,479 8,222 30,313 21,840 Merger integration expenses (1) 8,193 17,675 31,328 20,459 Acquisition costs (2) 13 32,932 79 40,712 Gain on marketable equity securities — (285) — (27,570) Other (3) 1,168 824 4,202 1,854 Adjusted EBITDA $ 61,139 $ 55,549 $ 184,149 $ 135,115 (1) For the three and nine months ended October 31, 2019, includes $1.2 million of stock-based compensation expense from post-Acquisition merger integration activities. (2) For the three and nine months ended October 31, 2019, includes $13.7 million of stock-based compensation expense from Acquisition-related cash and equity accelerations. (3) For the three months ended October 31, 2020 and 2019, Other consisted of amortization of incremental costs to obtain a contract of $0.6 million and $0.5 million, non-income-based taxes of $0.4 million and $0.2 million, and other costs of $0.2 million and $0.1 million, respectively. For the nine months ended October 31, 2020 and 2019, Other consisted of amortization of incremental costs to obtain a contract of $1.4 million and $1.4 million, non-income-based taxes of $1.2 million and $0.4 million, and other costs of $1.5 million and $0.1 million, respectively. The following table further sets forth our Adjusted EBITDA as a percentage of revenue: Three months ended October 31, Nine months ended October 31, (in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change Adjusted EBITDA $ 61,139 $ 55,549 $ 5,590 10 % $ 184,149 $ 135,115 $ 49,034 36 % As a percentage of revenue 34 % 35 % 34 % 41 % Our Adjusted EBITDA increased by $5.6 million, or 10%, from $55.5 million for the three months ended October 31, 2019 to $61.1 million for the three months ended October 31, 2020. The increase in Adjusted EBITDA was driven by the inclusion of WageWorks' results of operations for the full period of the current year, increased efficiency, and the overall growth of our business. Our Adjusted EBITDA increased by $49.0 million, or 36%, from $135.1 million for the nine months ended October 31, 2019 to $184.1 million for the nine months ended October 31, 2020. The increase in Adjusted EBITDA was driven by the inclusion of WageWorks' results of operations for the full period of the current year, increased efficiency, and the overall growth of our business. Our use of Adjusted EBITDA has limitations as an analytical tool, and it should not be considered in isolation nor as a substitute for analysis of our results as reported under GAAP. Key components of our results of operations Acquisition of WageWorks As the Acquisition closed on August 30, 2019, WageWorks' results of operations are included in our consolidated results of operations for the three and nine months ended October 31, 2020, but are only included in our consolidated results of operations for approximately two months out of each of the three and nine months ended October 31, 2019. In addition, the results of operations attributable to WageWorks may not be directly comparable to WageWorks' results of operations reported by WageWorks prior to the Acquisition. -24- Table of Contents Revenue We generate revenue from three primary sources: service revenue, custodial revenue, and interchange revenue. Service revenue. We earn service revenue from the fees we charge our Network Partners, Clients, and members for the administration services we provide in connection with the HSAs and other CDBs we offer. With respect to our Network Partners and Clients, our fees are generally based on a fixed tiered structure for the duration of the relevant service agreement and are paid to us on a monthly basis. We recognize revenue on a monthly basis as services are rendered to our members and Clients. As a result of the WageWorks Acquisition, service revenue now comprises a majority of our revenue. Custodial revenue. We earn custodial revenue primarily from our HSA Assets deposited with our Depository Partners and with our insurance company partners, Client-held funds deposited with our Depository Partners, and recordkeeping fees we earn in respect of mutual funds in which our members invest. We deposit HSA cash with our Depository Partners pursuant to contracts that (i) typically have terms ranging from three to five years, (ii) provide for a fixed or variable interest rate payable on the average daily cash balances deposited with the relevant Depository Partner, and (iii) have minimum and maximum required deposit balances. We deposit the Client-held funds with our Depository Partners in interest-bearing, demand deposit accounts that have a floating interest rate and no set term or duration. We earn custodial revenue on HSA Assets and Client-held funds that is based on the interest rates offered to us by these Depository 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 earn a recordkeeping fee, calculated as a percentage of custodial investments. We are continuing to transition HSA cash without yield to HSA cash with yield and expect to complete the transition in fiscal 2022. Interchange revenue. We earn interchange revenue each time one of our members uses one of our physical payment cards or virtual platforms to make a purchase. This revenue is collected each time a member “swipes” our payment card to pay expenses. We recognize interchange revenue monthly based on reports received from third parties, namely, the card-issuing banks and card processors. Cost of revenue Cost of revenue includes costs related to servicing accounts, managing Client and Network Partner relationships and processing reimbursement claims. Expenditures include personnel-related costs, depreciation, amortization, stock-based compensation, common expense allocations (such as office rent, supplies, and other overhead expenses), new member and participant supplies, and other operating costs related to servicing our members. Other components of cost of revenue include interest retained by members on HSA cash and interchange costs incurred in connection with processing card transactions for our members. Service costs. Service costs include the servicing costs described above. Additionally, for new accounts, we incur on-boarding costs associated with the new accounts, such as new member welcome kits, the cost associated with issuance of new payment cards, and costs of marketing materials that we produce for our Network Partners. Custodial costs. Custodial costs are comprised of interest retained by our HSA members, in respect of HSA cash with yield, and fees we pay to banking consultants whom we use to help secure agreements with our Depository Partners. Interest retained by HSA members is calculated on a tiered basis. The interest rates retained by HSA members can change based on a formula or upon required notice. Interchange costs. Interchange costs are comprised of costs we incur in connection with processing payment transactions initiated by our members. Due to the substantiation requirement on FSA/HRA-linked payment card transactions, payment card costs are higher for FSA/HRA card transactions. In addition to fixed per card fees, we are assessed additional transaction costs determined by the amount of the transaction. Gross profit and gross margin Our gross profit is our total revenue minus our total cost of revenue, 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 interest rates, the amount we charge our Network Partners, Clients, and members, the mix of our sources of revenue, how many services we deliver per account, and payment processing costs per account. 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 -25- Table of Contents expenses, marketing expenses, depreciation, amortization, stock-based compensation, and common expense allocations. Technology and development. Technology and development expenses include personnel and related expenses for software development and delivery, information technology, data management, product, and security. Technology and development expenses also include 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. General and administrative. General and administrative expenses include personnel and related expenses of, and professional fees incurred by our executive, finance, legal, internal audit, corporate development, compliance, and people departments. They also include depreciation, amortization, stock-based compensation, and common expense allocations. Amortization of acquired intangible assets. Amortization of acquired intangible assets results primarily from intangible assets acquired in connection with business combinations. The assets include acquired customer relationships, acquired developed technology, and acquired trade names and trademarks, which we amortize over the assets' estimated useful lives, estimated to be 10-15 years, 2-5 years, and 3 years, respectively. We also acquired intangible HSA portfolios from third-party custodians. We amortize these assets over the assets’ estimated useful life of 15 years. We evaluate our acquired intangible assets for impairment annually, or at a triggering event. Merger integration. Merger integration expenses include personnel and related expenses, including severance, professional fees, legal expenses, and facilities- and technology-related expenses directly related to integration activities to merge operations as a result of the Acquisition. Interest expense Interest expense consists of accrued interest expense and amortization of deferred financing costs associated with our credit agreement. Interest on our long-term debt changes frequently due to variable interest rate terms, and as a result, our interest expense is expected to fluctuate based on changes in prevailing interest rates. Other expense, net Other expense, net, primarily consists of acquisition costs, gains and losses on marketable equity securities, and non-income-based taxes, less interest income earned on corporate cash. Income tax provision As of December 31, 2019, we were subject to federal and state income taxes in the United States based on a calendar tax year-end; however, beginning January 31, 2020, we began reporting federal and state income taxes using a January 31 year-end, consistent with the financial reporting fiscal year. 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. Valuation allowances are established when necessary to reduce net deferred tax assets to the amount expected to be realized. As of October 31, 2020, we have recorded an overall net deferred tax liability with the exception of an insignificant amount of federal capital losses recorded as a net deferred tax asset on our condensed consolidated balance sheet. Comparison of the three and nine months ended October 31, 2020 and 2019 Impact of Acquisition The comparability of our operating results is impacted by our Acquisition of WageWorks on August 30, 2019. As the Acquisition closed on August 30, 2019, WageWorks' results of operations are included in our consolidated results of operations for the three and nine months ended October 31, 2020, but are only included in our consolidated results of operations for approximately two months out of each of the three and nine months ended October 31, 2019. Revenue and expense attributable to WageWorks generally is not separately identifiable due to the integration of WageWorks into our existing operations. -26- Table of Contents Revenue The following table sets forth our revenue for the periods indicated: Three months ended October 31, Nine months ended October 31, (in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change Service revenue $ 104,562 $ 87,620 $ 16,942 19 % $ 319,638 $ 140,710 $ 178,928 127 % Custodial revenue 48,544 46,972 1,572 3 % 142,352 132,538 9,814 7 % Interchange revenue 26,245 22,526 3,719 17 % 83,411 57,545 25,866 45 % Total revenue $ 179,351 $ 157,118 $ 22,233 14 % $ 545,401 $ 330,793 $ 214,608 65 % Service revenue. The $16.9 million, or 19%, increase in service revenue from the three months ended October 31, 2019 to the three months ended October 31, 2020 was primarily due to the inclusion for the full period of service revenue associated with the CDBs added through the Acquisition in the current year, partially offset by the negative impact of the COVID-19 pandemic on service revenues related to commuter benefits and other CDBs. The $178.9 million, or 127%, increase in service revenue from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was primarily due to the inclusion for the full period of service revenue associated with the CDBs added through the Acquisition in the current year, partially offset by the negative impact of the COVID-19 pandemic on service revenues related to commuter benefits and other CDBs. Custodial revenue. The $1.6 million, or 3%, increase in custodial revenue from the three months ended October 31, 2019 to the three months ended October 31, 2020 was primarily due to the $1.5 billion, or 21%, increase in the year-over-year average daily balance of HSA cash with yield. The increase was partially offset by a decrease in yield from 2.43% for the three months ended October 31, 2019 to 2.08% for the three months ended October 31, 2020, which was due in part to the interest rate cuts made by the Federal Reserve in response to the COVID-19 pandemic and due to the lower yield on HSA cash with yield added through the Acquisition. The $9.8 million, or 7%, increase in custodial revenue from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was primarily due to the $1.8 billion, or 27%, increase in the year-over-year average daily balance of HSA cash with yield. The increase was partially offset by a decrease in yield from 2.50% for the nine months ended October 31, 2019 to 2.10% for the nine months ended October 31, 2020, which was due in part to the interest rate cuts made by the Federal Reserve in response to the COVID-19 pandemic and due to the lower yield on HSA cash with yield added through the Acquisition. We are continuing to transition HSA cash without yield to HSA cash with yield and expect to complete the transition in fiscal 2022. This cash is being placed with our Depository Partners at prevailing interest rates, which we expect will generate additional custodial revenue. Interchange revenue. The $3.7 million, or 17%, increase in interchange revenue from the three months ended October 31, 2019 to the three months ended October 31, 2020 was primarily due to the inclusion for the full period of interchange revenue associated with the CDBs added through the Acquisition in the current year and an increased average interchange rate. The increase was partially offset by a decrease in spend per CDB, primarily with respect to FSA and commuter benefit accounts, as well as lower healthcare spending partially attributable to the restrictions imposed by local governments around the country in connection with the COVID-19 pandemic. The $25.9 million, or 45%, increase in interchange revenue from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was primarily due to the inclusion for the full period of interchange revenue associated with the CDBs added through the Acquisition in the current year and an increased average interchange rate. The increase was partially offset by a decrease in spend per CDB, primarily with respect to FSA and commuter benefit accounts, as well as lower healthcare spending partially attributable to the restrictions imposed by local governments around the country in connection with the COVID-19 pandemic. Total revenue. Total revenue increased by $22.2 million, or 14%, from the three months ended October 31, 2019 to the three months ended October 31, 2020, and by $214.6 million, or 65% from the nine months ended October 31, 2019 to the nine months ended October 31, 2020, due to the inclusion for the full period of WageWorks' results of operations and related realized net revenue synergies in the current year. Impact of COVID-19. Our business has been adversely affected by the recent outbreak of the COVID-19 virus, and we expect that it will continue to be adversely affected, including as a result of the associated interest rate cuts by the Federal Reserve and other market conditions that have caused interest rates to decline significantly. As a -27- Table of Contents result, funds that we place with our Depository Partners in this environment receive lower interest rates than we originally expected. Sales opportunities have also been impacted, with some opportunities delayed and most now being held virtually. In addition, we are required to support our Clients' open enrollment activities virtually. As an increasing number of companies go out of business, the number of our Clients and potential Clients is adversely affected. Increased unemployment may mean that fewer of our members contribute to HSAs, FSAs or other CDBs. We may be unable to meet our service level commitments to our Clients as a result of disruptions to our work force and disruptions to third party contracts that we rely on to provide our services. Our financial results related to certain of our products have also been adversely affected, such as commuter benefits, due to many of our members working from home during the outbreak and other impacts from the outbreak, and the "work from home" trend may continue after the pandemic. Clients may be unable to pay fees required under contracts and exercise "force majeure" or similar defenses, which would negatively impact our financial results. The extent to which the COVID-19 virus will continue to negatively impact our business remains highly uncertain and as a result may have a material adverse impact on our business and financial results. Cost of revenue The following table sets forth our cost of revenue for the periods indicated: Three months ended October 31, Nine months ended October 31, (in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change Service costs $ 65,936 $ 52,278 $ 13,658 26 % $ 202,195 $ 92,672 $ 109,523 118 % Custodial costs 4,762 4,384 378 9 % 14,805 12,716 2,089 16 % Interchange costs 4,095 4,421 (326) (7) % 13,985 13,177 808 6 % Total cost of revenue $ 74,793 $ 61,083 $ 13,710 22 % $ 230,985 $ 118,565 $ 112,420 95 % Service costs. The $13.7 million, or 26%, increase in service costs from the three months ended October 31, 2019 to the three months ended October 31, 2020 was primarily due to the inclusion for the full period of WageWorks' results of operations in the current year and the resulting higher volume of accounts being serviced, including additional hiring of personnel to implement and support our new Network Partners and HSAs, increases in stock-based compensation expense, and increases in other expenses. The $109.5 million, or 118%, increase in service costs from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was primarily due to the inclusion for the full period of WageWorks' results of operations in the current year and the resulting higher volume of accounts being serviced, including additional hiring of personnel to implement and support our new Network Partners and HSAs, increases in stock-based compensation expense, and increases in other expenses. Custodial costs. The $0.4 million, or 9%, increase in custodial costs from the three months ended October 31, 2019 to the three months ended October 31, 2020 was due to an increase in the average daily balance of HSA cash with yield, which increased from $7.1 billion for the three months ended October 31, 2019 to $8.7 billion for the three months ended October 31, 2020. The increase was partially offset by a lower average interest rate paid on HSA cash with yield, which decreased from 0.21% for the three months ended October 31, 2019 to 0.18% for the three months ended October 31, 2020. The $2.1 million, or 16%, increase in custodial costs from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was due to an increase in the average daily balance of HSA cash with yield, which increased from $6.7 billion for the nine months ended October 31, 2019 to $8.4 billion for the nine months ended October 31, 2020. The increase was partially offset by a lower average interest rate paid on HSA cash with yield, which decreased from 0.22% for the nine months ended October 31, 2019 to 0.20% for the nine months ended October 31, 2020. Interchange costs. The $0.3 million, or 7%, decrease in interchange costs from the three months ended October 31, 2019 to the three months ended October 31, 2020 was due to a decrease in card spend per account as a result of the local government restrictions in response to the COVID-19 pandemic, partially offset by an overall increase in average Total Accounts, which increased primarily due to the inclusion for the full period of accounts added through the Acquisition of WageWorks in the current year. The $0.8 million, or 6%, increase in interchange costs from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was due to an overall increase in average Total Accounts, which increased primarily due to the inclusion for the full period of accounts added through the Acquisition of WageWorks in the -28- Table of Contents current year, partially offset by a decrease in card spend per account as a result of the local government restrictions in response to the COVID-19 pandemic. Total cost of revenue. As we continue to add Total Accounts, we expect that our cost of revenue will increase in dollar amount to support our Network Partners, Clients, and members. Cost of revenue will continue to be affected by a number of different factors, including our ability to scale our service delivery, Network Partner implementation, account management functions, and the impact of the COVID-19 pandemic. Operating expenses The following table sets forth our operating expenses for the periods indicated: Three months ended October 31, Nine months ended October 31, (in thousands, except percentages) 2020 2019 $ Change % Change 2020 2019 $ Change % Change Sales and marketing $ 12,880 $ 12,654 $ 226 2 % $ 36,502 $ 30,015 $ 6,487 22 % Technology and development 30,758 23,511 7,247 31 % 92,490 46,061 46,429 101 % General and administrative 22,099 19,222 2,877 15 % 61,590 37,193 24,397 66 % Amortization of acquired intangible assets 19,126 13,051 6,075 47 % 56,905 16,036 40,869 255 % Merger integration 8,193 17,675 (9,482) (54) % 31,328 20,459 10,869 53 % Total operating expenses $ 93,056 $ 86,113 $ 6,943 8 % $ 278,815 $ 149,764 $ 129,051 86 % Sales and marketing. The $0.2 million, or 2%, increase in sales and marketing expense from the three months ended October 31, 2019 to the three months ended October 31, 2020 was primarily due to the inclusion for the full period of WageWorks' results of operations in the current year, which resulted in increased staffing, increases in other expenses, and higher stock-based compensation expense, partially offset by increased efficiencies. The $6.5 million, or 22%, increase in sales and marketing expense from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was primarily due to the inclusion for the full period of WageWorks' results of operations in the current year, which resulted in increased staffing, increases in other expenses, and higher stock-based compensation expense, partially offset by increased efficiencies. 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. On an annual basis, we expect our sales and marketing expenses to remain relatively steady as a percentage of our total revenue. However, 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. The $7.2 million, or 31%, increase in technology and development expense from the three months ended October 31, 2019 to the three months ended October 31, 2020 was primarily due to the inclusion for the full period of WageWorks' results of operations in the current year, which resulted in increased personnel-related expense, increases in professional fees, increased stock-based compensation expense, increases in amortization and depreciation, and other increases, which were partially offset by increases in capitalized development and operating efficiencies. The $46.4 million, or 101%, increase in technology and development expense from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was primarily due to the inclusion for the full period of WageWorks' results of operations in the current year, which resulted in increased personnel-related expense, increases in professional fees, increased stock-based compensation expense, increases in amortization and depreciation, and other increases, which were partially offset by increases in capitalized development and operating efficiencies. We expect our technology and development expenses to increase for the foreseeable future as we continue to invest in the development and security of our proprietary platforms. On an annual basis, we expect our technology and development expenses to increase as a percentage of our total revenue pursuant to our growth initiatives. 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. The $2.9 million, or 15%, increase in general and administrative expense from the three months ended October 31, 2019 to the three months ended October 31, 2020 was primarily due to the inclusion for the full period of WageWorks' results of operations in the current year, which resulted in increased -29- Table of Contents personnel-related expense, increases in professional fees, and increased stock-based compensation expense, partially offset by increased efficiencies. The $24.4 million, or 66%, increase in general and administrative expense from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was primarily due to the inclusion for the full period of WageWorks' results of operations in the current year, which resulted in increased personnel-related expense, increases in professional fees, and increased stock-based compensation expense, partially offset by increased efficiencies. We expect our general and administrative expenses to increase for the foreseeable future due to the additional demands on our legal, compliance, accounting, and insurance functions that we incur as we continue to grow our business, as well as other costs associated with being a public company. On an annual basis, we expect our general and administrative expenses to remain relatively steady as a percentage of our total revenue over the near term pursuant to our growth initiatives. 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. The $6.1 million increase in amortization of acquired intangible assets from the three months ended October 31, 2019 to the three months ended October 31, 2020 was due to the inclusion for the full period of amortization related to identified intangible assets acquired through the Acquisition of WageWorks in the current year. The $40.9 million increase in amortization of acquired intangible assets from the nine months ended October 31, 2019 to the nine months ended October 31, 2020 was due to the inclusion for the full period of amortization related to identified intangible assets acquired through the Acquisition of WageWorks in the current year. Merger integration. The $8.2 million and $31.3 million in merger integration expense for the three and nine months ended October 31, 2020, respectively, was due to personnel and related expenses, including expenses incurred in conjunction with the migration of accounts, severance, professional fees, technology-related, and facilities expenses directly related to the Acquisition of WageWorks. We expect integration expenses totaling approximately $100 million in the aggregate to continue for 24 to 36 months following the closing of the Acquisition, which closed on August 30, 2019. As of October 31, 2020, we had incurred a total of approximately $63 million of non-recurring merger integration costs related to the Acquisition of WageWorks. Interest expense The $7.0 million and $28.1 million in interest expense for the three and nine months ended October 31, 2020 consists primarily of interest accrued under our term loan facility and amortization of financing costs. We expect interest expense to decrease as a result of the principal repayments under our term loan facility. Other expense, net The $30.5 million decrease in other expense, net, from $30.9 million during the three months ended October 31, 2019 to $0.4 million during the three months ended October 31, 2020 was primarily due to a $32.9 million decrease in acquisition costs. The remainder of the change was due to a decrease in interest income of $1.9 million, an increase in other expense of $0.2 million, and a $0.3 million non-recurring gain in connection with our equity investment in WageWorks during the three months ended October 31, 2019. The $6.3 million decrease in other expense, net, from $8.3 million during the nine months ended October 31, 2019 to $2.0 million during the nine months ended October 31, 2020 was primarily due to a $40.6 million decrease in acquisition costs and a $27.6 million non-recurring gain in connection with our equity investment in WageWorks during the three months ended October 31, 2019. The remainder of the change was due to a decrease in interest income of $4.4 million and an increase in other expense of $2.3 million. Income tax provision (benefit) Income tax expense for the three and nine months ended October 31, 2020 was $2.3 million and $2.0 million, respectively, as compared to income tax benefit of $9.9 million and income tax expense of $3.9 million for the three and nine months ended October 31, 2019, respectively. The tax provision for the three months ended October 31, 2020 increased $12.2 million compared to the three months ended October 31, 2019. The tax provision for the nine months ended October 31, 2020 decreased $1.9 million compared to the nine months ended October 31, 2019. The change was primarily due to a significant decrease in pre-tax book income coupled with a decrease in excess tax benefits on stock-based compensation expense and return-to-provision adjustments, which were partially offset by state apportionment changes recognized in the provision for income taxes. -30- Table of Contents Our effective income tax provision rate for the three and nine months ended October 31, 2020 was 56.7% and 36.8%, respectively, compared to an income tax benefit rate of 31.7% and income tax provision rate of 8.9% for the three and nine months ended October 31, 2019, respectively. The 88.4 and 27.9 percentage point increase for the three and nine months ended October 31, 2020, respectively, compared to the three and nine months ended October 31, 2019 was primarily due to the impact of excess tax benefits on stock-based compensation expense and return-to-provision adjustments, which were partially offset by state apportionment changes recognized in the provision for income taxes relative to pre-tax book income. Seasonality Seasonal concentration of our growth combined with our recurring revenue model create seasonal variation in our results of operations. Revenue results are seasonally impacted due to ancillary service fees, timing of HSA contributions, and timing of card spend. Cost of Revenue is seasonally impacted as a significant number of new and existing Network Partners bring us new HSAs and CDBs beginning in January of each year concurrent with the start of many employers’ benefit plan years. Before we realize any revenue from these new accounts, we incur costs related to implementing and supporting our new Network Partners and new accounts. These costs of services relate to activating accounts and hiring additional staff, including seasonal help to support our member support center. These expenses begin to ramp up during our third fiscal quarter, with the majority of expenses incurred in our fourth fiscal quarter. Liquidity and capital resources Cash and cash equivalents overview Our principal source of liquidity is our current cash and cash equivalents balances, collections from our service, custodial, and interchange revenue activities, and availability under our revolving credit facility described below. 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, payments under our term loan facility, and capital expenditures. As of October 31, 2020 and January 31, 2020, cash and cash equivalents were $299.4 million and $191.7 million, respectively. Cash and cash equivalents as of October 31, 2020 included approximately $286.8 million of net proceeds we received from our follow-on public offering in July 2020 from the sale of 5,290,000 shares of our common stock, less the $200.0 million we used to prepay long-term debt. Capital resources We have a “shelf” registration statement on Form S-3 on file with the SEC. This shelf registration statement, which includes a base prospectus, allows us at any time to offer any combination of securities described in the prospectus in one or more offerings. Unless otherwise specified in a prospectus supplement accompanying the base prospectus, we would use the net proceeds from the sale of any securities offered pursuant to the shelf registration statement for general corporate purposes, including, but not limited to, working capital, sales and marketing activities, general and administrative matters and capital expenditures, and if opportunities arise, for the acquisition of, or investment in, assets, technologies, solutions or businesses that complement our business. Pending such uses, we may invest the net proceeds in interest-bearing securities. In addition, we may conduct concurrent or other financings at any time. In July 2020, we closed a follow-on public offering of 5,290,000 shares of common stock at a public offering price of $56.00 per share, less the underwriters' discount. We received net proceeds of approximately $286.8 million after deducting underwriting discounts and commissions of approximately $8.9 million and other offering expenses of approximately $0.6 million. Our credit agreement includes a five-year senior secured revolving credit facility in an aggregate principal amount of up to $350.0 million, which may be used for working capital and general corporate purposes, including the financing of acquisitions and other investments. For a description of the terms of the credit agreement, refer to Note 8—Indebtedness. We were in compliance with all covenants under the credit agreement as of October 31, 2020, and for the period then ended. Use of cash We used a portion of the net proceeds from the follow-on public offering to prepay $200.0 million under our term loan facility, with the remaining proceeds to be used for general corporate purposes, which may include additional prepayments under our term loan facility or potential acquisitions. -31- Table of Contents Capital expenditures for the nine months ended October 31, 2020 and 2019 were $48.6 million and $22.4 million, respectively. We expect to continue our current level of increased capital expenditures for the remainder of the fiscal year ending January 31, 2021 as we continue to devote a significant amount of our capital expenditures to improving the architecture and functionality of our proprietary systems. Costs to improve the architecture of our proprietary systems include computer hardware, personnel and related costs for software engineering and outsourced software engineering services. We believe our existing cash, cash equivalents, and revolving credit facility 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. In the event that additional financing is required, we may not be able to raise it 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: Nine months ended October 31, (in thousands) 2020 2019 Net cash provided by operating activities $ 120,717 $ 74,070 Net cash used in investing activities (76,730) (1,715,393) Net cash provided by financing activities 63,643 1,454,405 Decrease in cash and cash equivalents 107,630 (186,918) Beginning cash and cash equivalents 191,726 361,475 Ending cash and cash equivalents $ 299,356 $ 174,557 Cash flows from operating activities. Net cash provided by operating activities during the nine months ended October 31, 2020 resulted from net income of $3.5 million, plus depreciation and amortization expense of $85.5 million, stock-based compensation expense of $30.3 million, and amortization of debt issuance costs of $3.8 million, partially offset by other non-cash items and working capital changes totaling $2.4 million. Net cash provided by operating activities during the nine months ended October 31, 2019 resulted from net income of $39.9 million, plus stock-based compensation expense of $31.2 million, depreciation and amortization expense of $28.8 million, amortization of debt issuance costs of $1.1 million, and other non-cash items and working capital changes totaling $0.7 million, partially offset by gains on marketable equity securities of $27.6 million. Cash flows from investing activities. Cash used in investing activities for the nine months ended October 31, 2020 resulted from $37.2 million in software and capitalized software development, $28.1 million in acquisitions of intangible member assets, and $11.4 million in purchases of property and equipment. Cash used in investing activities during the nine months ended October 31, 2019 was primarily the result of the Acquisition of WageWorks for $1.63 billion, net of cash acquired, and purchases of marketable equity securities of $53.8 million. In addition, we invested $17.2 million in software and capitalized software development, $5.2 million in purchases of property and equipment, and $9.1 million in acquisitions of intangible member assets. Cash flows from financing activities. Net cash provided by financing activities during the nine months ended October 31, 2020 resulted from $286.8 million of net proceeds from our July 2020 follow-on public offering of 5,290,000 shares of common stock and the exercise of stock options of $4.5 million. These items were partially offset by $223.4 million of principal payments on our long-term debt and $4.2 million used in the settlement of Client-held funds obligation. Net cash provided by financing activities during the nine months ended October 31, 2019 resulted from net borrowings of $1.22 billion under our term loan facility, net proceeds of $458.5 million from the sale of 7,762,500 shares of our common stock in our July 2019 follow-on offering, and the exercise of stock options of $7.3 million. These items were partially offset by $230.9 million of cash used to settle Client-held funds obligations. Contractual obligations Except for the $200.0 million prepayment under our term loan facility in July 2020, there were no material changes during the nine months ended October 31, 2020, outside of the ordinary course of business, in our contractual obligations from those disclosed in our Annual Report on Form 10-K for the fiscal year ended January 31, 2020. -32- Table of Contents Off-balance sheet arrangements As of October 31, 2020, other than outstanding letters of credit issued under our revolving credit facility, we did not have any off-balance sheet arrangements. The majority of the standby letters of credit expire within one year. However, in the ordinary course of business, we will continue to renew or modify the terms of the letters of credit to support business requirements. The letters of credit are contingent liabilities, supported by our revolving credit facility, and are not reflected on our condensed consolidated balance sheets. Critical accounting policies and significant management estimates Our management’s discussion and analysis of financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these unaudited condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions. Our significant accounting policies are more fully described in Note 1 of the accompanying unaudited condensed consolidated financial statements and in Note 1 to our audited consolidated financial statements contained in our Annual Report on Form 10-K for the fiscal year ended January 31, 2020. There have been no significant or material changes in our critical accounting policies during the nine months ended October 31, 2020, as compared to those disclosed in “Management’s discussion and analysis of financial condition and results of operations – Critical accounting policies and significant management estimates” in our Annual Report on Form 10-K for the fiscal year ended January 31, 2020. Recent accounting pronouncements See Note 1. Summary of business and significant accounting policies within the interim financial statements included in this Form 10-Q for further discussion. Item 3. Qualitative and quantitative disclosures about market risk 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 nine months ended October 31, 2020 and 2019, no one customer accounted for greater than 10% of our total revenue. We monitor market and regulatory changes regularly and make adjustments to our business if necessary. Inflation. Inflationary factors may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of expenses as a percentage of revenue if our revenue does not correspondingly increase with inflation. Concentration of credit risk Financial instruments, which potentially subject us to concentrations of credit risk, consist primarily of cash and cash equivalents. We maintain our cash and cash equivalents in bank and other depository accounts, which frequently may exceed federally insured limits. Our cash and cash equivalents as of October 31, 2020 were $299.4 million, of which $2.3 million was covered by federal depository insurance. We have not experienced any material losses in such accounts and believe we are not exposed to any significant credit risk with respect to our cash and cash equivalents. Our accounts receivable balance as of October 31, 2020 was $64.3 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; however, the extent to which the ongoing COVID-19 pandemic will negatively impact our credit risk is highly uncertain and cannot be accurately predicted. We continue to monitor our credit risk and place our cash and cash equivalents with reputable financial institutions. -33- Table of Contents Interest rate risk HSA Assets and Client-held funds. Our HSA Assets consists of custodial HSA funds we hold in custody on behalf of our members. As of October 31, 2020, we had HSA Assets of approximately $12.4 billion. As a non-bank custodian, we contract with our Depository Partners and insurance company partners to hold custodial cash assets on behalf of our members, and we earn a significant portion of our total revenue from interest paid to us by these partners. The contract terms typically range from three to five years and have either fixed or variable interest rates. As our HSA Assets increase and existing contracts expire, we seek to enter into new contracts with Depository Partners, the terms of which are impacted by the then-prevailing interest rate environment. The diversification of deposits among Depository Partners and varied contract terms substantially reduces our exposure to short-term fluctuations in prevailing interest rates and mitigates the short-term impact of a sustained increase or decline in prevailing interest rates on our custodial revenue. A sustained decline in prevailing interest rates may negatively affect our business by reducing the size of the interest rate yield, or yield, available to us and thus the amount of the custodial revenue we can realize. Conversely, a sustained increase in prevailing interest rates can increase our yield. An increase in our yield would increase our custodial revenue as a percentage of total revenue. In addition, if our yield increases, we expect the spread to also increase between the interest offered to us by our Depository Partners and the interest retained by our members, thus increasing our profitability. However, we may be required to increase the interest retained by our members in a rising prevailing interest rate environment. Changes in prevailing interest rates are driven by macroeconomic trends and government policies over which we have no control, such as the interest rate cuts by the Federal Reserve associated with the ongoing COVID-19 pandemic. Our Client-held funds are interest earning deposits from which we generate custodial revenue. As of October 31, 2020, we had Client-held funds of approximately $798.0 million. These deposits are amounts remitted by Clients and held by us on their behalf to pre-fund and facilitate administration of our other CDBs. These deposits are held with Depository Partners. We deposit the Client-held funds with our Depository Partners in interest-bearing, demand deposit accounts that have a floating interest rate and no set term or duration. A sustained decline in prevailing interest rates may negatively affect our business by reducing the size of the yield available to us and thus the amount of the custodial revenue we can realize from Client-held funds. Changes in prevailing interest rates are driven by macroeconomic trends and government policies over which we have no control. Cash and cash equivalents . We consider all highly liquid investments purchased with an original maturity of three months or less to be unrestricted cash equivalents. Our unrestricted cash and cash equivalents are held in institutions in the U.S. and include deposits in a money market account that is unrestricted as to withdrawal or use. As of October 31, 2020, we had unrestricted cash and cash equivalents of $299.4 million. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our cash and cash equivalents as a result of changes in interest rates. Credit agreement. As of October 31, 2020, we had $1.02 billion outstanding under our term loan facility and no amounts drawn under our revolving credit facility. Our overall interest rate sensitivity under these credit facilities is primarily influenced by any amounts borrowed and the prevailing interest rates on these instruments. The interest rate on our term loan credit facility and revolving credit facility is variable and was 1.65 percent at October 31, 2020. Accordingly, we may incur additional expense if interest rates increase in future periods. For example, a one percent increase in the interest rate on the amount outstanding under our credit facilities at October 31, 2020 would result in approximately $10.1 million of additional interest expense over the next 12 months.