The following table sets forth the location, approximate square footage and primary use of each of the principal properties we occupied at December 31, 2006:
We lease or sublease all of these properties. We believe our existing facilities are adequate to meet our needs for the next twelve months.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Since our incorporation in November 1997, we have spent approximately $55 million on technology and content related to our ecommerce platform. We have also invested significant time and resources in obtaining licenses to sell health insurance in all 50 states and the District of Columbia, developing diverse and successful member acquisition programs and establishing relationships with over 160 health insurance carriers, enabling us to offer more than 7,000 health insurance products online. Our first online transaction relating to the sale of a health insurance policy was completed during the fourth quarter of 1998.
We believe that there is significant opportunity to expand our share of the individual, family and small business health insurance markets and thereby increase our revenue. For example, we estimate our share of the individual and family health insurance market as of December 31, 2006 represented approximately 2% of the total market, assuming 17 million individuals in the United States directly purchased their health insurance coverage as reported by the U.S. Census Bureau in 2004. Historically, our revenue and business have been more significantly affected by the rate of growth in the number of consumers using the Internet to research and purchase health insurance than by the rate at which the health insurance industry has grown. We expect that the rate of online adoption will continue to be a primary driver of our revenue.
for achieving sales volume thresholds or other objectives. Commission rates vary by carrier and by the type of plan purchased by a member. Commission rates also can vary based upon the amount of time that the policy has been active, with commission rates for individual and family policies typically being higher in the first twelve months of the policy. Individuals, families and small businesses purchasing health insurance through us typically pay their premiums on a monthly basis. Insurance carriers typically pay us our commissions monthly, after they receive the premium payment from the member. We continue to receive the commission payment from the relevant insurance carrier until the health insurance policy is cancelled or we otherwise do not remain the agent on the policy. As a result, the majority of our revenue is recurring in nature and grows in correlation with the growth we experience in our membership base. At the beginning of an accounting period, we have visibility with respect to the majority of our revenue for that accounting period since revenue for that accounting period is primarily attributable to policies previously purchased by our members.
We recognize commission revenue when the commission is reported to us by a carrier, which occurs through our receipt of a cash payment and a commission statement. We report commission revenue net of an allowance for future forfeiture amounts payable to our carriers due to policy cancellations. Commission override payments, which are recognized on the same basis as premium commissions, are generally reported to us in a more irregular pattern than premium commissions. As a result, our revenue for a particular quarter could be higher or lower than expectations due to the timing of the reporting of commission override payments.
Revenue attributable to individual and family product offerings in each of the years ended December 31, 2005 and 2006 represented approximately 80% of our total revenue. We define individual and family product offerings as major medical individual and family health insurance plans, which does not include small business, short-term major medical, stand-alone dental, life and student health insurance product offerings.
In addition to the revenue we derive from the sale of health insurance products, we derive revenue from our online sponsorship advertising program and from licensing the use of our ecommerce technology. Our sponsorship advertising program allows carriers to purchase advertising space in specific markets in a sponsorship area on our website. Specifically, carriers who have purchased advertising can choose to have specific health insurance plans displayed prominently after a consumer has entered certain census information. In return, we are typically paid a monthly fee and a performance fee based on metrics such as submitted or approved health insurance applications. Our technology licensing business allows carriers to offer their own health insurance policies on their websites and agents to utilize our technology to power their quoting and online content. These parties typically pay us certain guaranteed and performance-based fees.
individual and family health insurance products for which we paid fees to our marketing partners constituted approximately 26%, 34% and 35%, respectively, of all individual and family health insurance applications submitted on our website. Our marketing partner channel is the primary driver of our small business member acquisition.
Paid keyword search advertising on search engines represents the majority of expenses in our online advertising channel. We incur expenses associated with search engine advertising in the period in which the
consumer clicks on the advertisement. We actively manage our paid keyword search advertising expense, taking into account the anticipated return from referrals. We also take into account the productivity and relative cost of paid keyword search as compared to other marketing channels and the anticipated lifetime revenue from members acquired, to control the amount of expense incurred during a given period.
Customer care and enrollment expenses consist of compensation and related expenses for personnel engaged in pre-sales assistance to applicants who call our customer care center and enrollment personnel who assist applicants during the underwriting process. We expect customer care and enrollment expenses to increase in future periods.
Technology and content expenses consist primarily of compensation and related expenses for personnel associated with developing and enhancing our website technology as well as maintaining our website. A portion of our technology and content group is located at our wholly-owned subsidiary in China, where technology development costs are generally lower. Our technology and content expenses incurred in China totaled $0.4 million, $0.7 million and $1.0 million during the years ended December 31, 2004, 2005 and 2006, respectively. We expect our technology and content expenses to increase in absolute dollars in the future due to our increased focus on technology development, including the enhancement of our ecommerce platform. Additionally, our technology and content expenses could increase significantly if we decide to pursue expansion opportunities outside of the United States.
The following table shows certain selected metrics relating to our quarterly periods ended March 31, June 30, September 30 and December 31, 2006 and 2005:
(1) Individual and Family Product (“IFP”) applications completed on eHealth’s website during the period.
(2) Percentage of submitted applications from applicants who came directly to the eHealth website through unpaid search engine results or otherwise.
(3) Percentage of submitted applications from applicants sourced through eHealth’s network of marketing partners.
(4) Percentage of submitted applications from applicants sourced through paid search, portals and related sites.
(9) Marketing and advertising expenses for the period from the profit and loss statements.
(12) Estimated number of members active on all insurance policies as of the date indicated.
In October 2006, we completed an initial public offering in which we issued and sold 5,750,000 shares of our common stock, including 750,000 shares sold pursuant to the full exercise of the underwriters’ over-allotment option, at an issuance price to the public of $14.00 per share. We raised approximately $70.2 million in net proceeds after deducting underwriting discounts and commissions of $5.7 million and offering expenses of $4.6 million. We currently have no specific plans for the use of the net proceeds of this offering although we anticipate that we will use the net proceeds for working capital and other general corporate purposes, including the funding of our marketing activities and the costs of operating as a public company, as well as further investment in the development of our proprietary technologies. We may use a portion of the net proceeds for the acquisition of businesses, products and technologies that we believe are complementary to our own. Pending this use, we are in the process of investing the net proceeds in short-term, interest-bearing, investment-grade securities.
We recognize commission revenue when our commission is reported to us by a health insurance carrier, net of an allowance for future forfeiture amounts payable to carriers due to policy cancellations. Commissions are reported to us by a cash payment and commission statement. We use the data in the commission statements to identify the members for which we are receiving a commission payment and the amount received for each member, and to estimate our allowance for forfeitures payable to carriers. We are not obligated with respect to the insurance coverage sold through our ecommerce platform. As a result, we recognize the net amount of compensation earned as the agent in the transaction.
Commission override revenue, which we recognize on the same basis as premium commissions, is generally reported to us in a more irregular pattern than premium commissions. As a result, our revenues for a particular quarter could be higher or lower than expectations due to the timing of the reporting of commission override revenue to us.
We also generate revenue from the licensing of our technology to third parties, such as carriers and agents. Typically, we are paid a one-time implementation fee, which we recognize on a straight-line basis over the initial term of the agreement, commencing once the technology is available for use by the third party. In addition, we typically generate revenue based on performance criteria that is either measured based on data that is tracked by us, or based on data that is tracked by the third party. In instances where the performance criteria data is tracked by us, we recognize revenue in the period of performance. In instances where the performance criteria data is tracked by the third party, we recognize revenue when the amounts earned are both fixed and determinable and collection is reasonably assured. Typically, this occurs through our receipt of a cash payment from the third party along with a detailed statement containing the data that is tracked by the third party.
We defer revenue amounts that have been reported to us related to transactions where our services are complete, but where we cannot currently estimate the allowance for future forfeitures related to those amounts, and we defer revenue amounts collected from sponsorship or technology licensing customers in advance of our
performing our service for such customers. For example, at June 30, 2006, deferred revenue on our consolidated balance sheet included $0.7 million related to a single health insurance carrier that, effective January 2005, changed its basis for calculating and reporting commission amounts from a percentage of the premium it collected to a percentage of the premium it billed. Since this was the first carrier to calculate and report commission amounts on this basis, we did not have sufficient historical forfeiture experience to estimate and record an appropriate allowance for forfeitures as commission amounts were reported to us by the carrier. Accordingly, all commission amounts reported to us by the carrier since the beginning of 2005 were deferred. During the third quarter ended September 30, 2006, we determined we had sufficient experience to estimate an allowance for forfeitures for this carrier, at which time all amounts previously deferred were recorded as revenue, net of an allowance for forfeitures.
We account for internal-use software and website development costs in accordance with the guidance set forth in Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, and EITF Issue No. 00-2, Accounting for Web Site Development Costs. We capitalize costs of materials, consultants and compensation and related expenses of employees who devote time to the development of internal-use software; however, we expense as incurred all website development costs for new features and functionalities since it is not probable that they will result in additional functionality until they are both developed and tested with confirmation that they are more effective than the current set of features and functionalities on our website. Our judgment is required in determining the point at which various projects enter the states 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, which is generally three years. To the extent that we change the manner in which we develop and test new features and functionalities related to our website, assess the ongoing value of capitalized assets or determine the estimated useful lives over which the costs are amortized, the amount of website development costs we capitalize and amortize in future periods would be impacted. As of December 31, 2005, the net book value of capitalized internal-use software totaled $90,000. At December 31, 2006, our capitalized internal-use software was fully depreciated and had a net book value of zero.
During the year ended December 31, 2006, we recorded stock-based compensation expense totaling $283,000 related to stock options, restricted stock awards and restricted stock units granted to employees and accounted for in accordance with the provisions of SFAS 123R. At December 31, 2006, total unrecognized stock- based compensation cost related to stock options, restricted stock awards and restricted stock units granted to employees under our stock plans and accounted for in accordance with SFAS 123R was approximately
Stock-based compensation expense recognized during the year ended December 31, 2006 consisted of stock-based compensation related to stock option and restricted stock awards granted prior to January 1, 2006, which was calculated in accordance with APB 25, and stock-based compensation for all stock-based awards granted on or after January 1, 2006, based on the grant-date fair value estimated in accordance with SFAS 123R. The adoption of SFAS 123R will result in higher amounts of stock-based compensation expense in the future for awards granted after January 1, 2006 than would have been recorded if we had continued to apply the provisions of APB 25. The grant date fair value was determined using the Black-Scholes-Merton pricing model and a single option award approach. The weighted-average expected term for stock options granted was calculated using the simplified method in accordance with the provisions of Staff Accounting Bulletin No. 107, Share-Based Payment. The simplified method defines the expected term as the average of the contractual term and the vesting period of the stock option. We have estimated the volatility and forfeiture rates used as inputs to the model based on an analysis of our stock price since our IPO in October 2006, as well as an analysis of the most similar public companies for which we have data. We have used judgment in selecting these companies, as well as evaluating the available historical and implied volatility and forfeiture data for these companies. We will continue to use judgment in evaluating the expected term, volatility and forfeiture rate related to our own stock-based awards on a prospective basis, and incorporating these factors into the model.
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes. This process involves estimating our actual current tax expense together with assessing temporary differences that may result in deferred tax assets. Our effective tax rates in 2004 and 2005 were substantially lower than the statutory federal rate primarily due to our utilization of net operating loss credit carryforwards, which totaled $64.4 million for federal income tax purposes and $33.3 million for state income tax purposes at December 31, 2006. Our effective tax rate in 2006 differed from the statutory federal tax rate primarily due to the partial release of our valuation allowance against deferred tax assets in 2006. We expect our effective tax rate will be more in line with statutory federal and state tax rates in 2007; however, due to the large amount of remaining net operating loss credit carryforwards, we expect to continue to pay federal and state taxes at the alternative minimum tax rate in 2007, which is approximately 3% on a cash basis. Future changes in various factors, such as the amount of stock-based compensation we record during the year, potential limitations on the use of our federal and state net operating loss credit carryforwards, pending or future tax law changes including rate changes and the tax benefit from research and development credits, changes in our valuation allowance and state and foreign taxes, would impact our estimates, and as a result, could affect our effective tax rate and the amount of income tax expense we record, and pay, in future periods.
The following table presents our commission, sponsorship, licensing and other and total revenue for the years ended December 31, 2004, 2005 and 2006 and the dollar and percentage change from the prior year (dollars in thousands):
Total revenue increased $19.6 million, or 47%, in 2006 compared to 2005, primarily due to an increase in commission revenue as a result of an increase in our membership. Our estimated membership increased approximately 42% to 393,900 at December 31, 2006 from 277,600 at December 31, 2005. Included in commission revenue for 2006 was $0.5 million of commission revenue we recognized from certain small business members who were transferred to us by a partner with whom we share a percentage of the ongoing commissions we receive on these transferred policies. We expect these transfers to continue to occur into 2007, although at a slower rate than we have previously experienced. Commission revenue for 2006 also included the recognition of $0.5 million of revenue related to commissions received from a single health insurance carrier during 2005, which were included in deferred revenue at December 31, 2005. Sponsorship, licensing and other revenue increased $1.9 million in 2006 compared to 2005, primarily due to additional carrier sponsorships on our website and, to a lesser extent, new licensing arrangements related to our technology.
Total revenue increased $11.5 million, or 38%, in 2005 compared to 2004, primarily due to an increase in commission revenue as a result of an increase in our membership. Our estimated membership increased approximately 31% to 277,600 at December 31, 2005 from 212,400 at December 31, 2004. Sponsorship, licensing and other revenue increased by $83,000 in 2005 compared to 2004 primarily due to additional carrier sponsorships on our website.
The following table presents our marketing and advertising expenses for the years ended December 31, 2004, 2005 and 2006 and the dollar and percentage change from the prior year (dollars in thousands):
Marketing and advertising expenses increased by $3.6 million, or 20%, in 2006 compared to 2005. This was primarily due to a $3.8 million increase in marketing partner channel expenses. Additionally, online advertising expenses increased $0.8 million due to an increase in paid keyword search costs on Internet search engines, partially offset by a $0.9 million decrease in publicity campaigns during 2006. The growth in our advertising channel expenses was primarily related to an increase in the number of applications submitted on our website from the marketing partner channel and an increase in the volume of click-throughs from the online advertising channel during 2006 compared to 2005. Our acquisition cost per member, which we define as total marketing and advertising expenses for a period divided by the number of members included on applications for individual and family product offerings submitted during the period, decreased 10% to $46 in 2006 from $51 in 2005, primarily due to the increased efficiencies in our online marketing programs. As a percentage of total revenue, total marketing and advertising expenses decreased to 35% in 2006 from 43% in 2005.
We expect the average cost of acquiring new members to fluctuate based upon several factors, including the mix of health insurance applications submitted through our three marketing channels, the mix of marketing partners referring consumers to our website, the overall trend in costs of online marketing including keywords
purchased by us, seasonality patterns, the amounts we pay marketing partners to refer consumers to our website, fluctuations in the percentage of consumers referred to our website who submit health insurance applications and the level of personnel costs required to manage our marketing and advertising programs. Additionally, we may explore new marketing initiatives as part of our efforts to drive more consumers to our website. These initiatives may increase our acquisition cost per member if they do not result in a sufficient number of additional members to justify the expenditure.
The following table presents our customer care and enrollment expenses for the years ended December 31, 2004, 2005 and 2006 and dollar and percentage change from the prior year (dollars in thousands):
Customer care and enrollment expenses increased by $1.2 million, or 16%, for the year ended December 31, 2005 compared to the year ended December 31, 2004. This was primarily due to higher compensation and related expenses associated with an increase in personnel necessary to service the increased volume of submitted applications through our website. As a percentage of total revenue, customer care and enrollment expenses decreased to 21% in 2005 from 25% in 2004 as a result of economies of scale achieved by our customer care and enrollment operations in 2005.
We expect customer care and enrollment expenses to increase in absolute dollars as we hire additional personnel to service the growth in health insurance applications submitted through our website.
Technology and content expenses increased by $2.1 million, or 26%, in 2006 compared to 2005. This increase was primarily due to a $1.2 million increase in compensation and related expenses associated with an increase in the number of personnel necessary to develop and maintain our technology and website content. Additionally, technology and content expenses increased as a result of a $0.3 million increase in facility-related expenses due to our new leased data center in San Jose, California and our new office lease in Xiamen, China, a $0.2 million increase in stock-based compensation expenses as a result of our adoption of SFAS 123R in 2006 and a $0.1 million increase in service obligation expenses due to an arrangement we entered into in November 2005 for a third-party to provide certain information services for our website. As a percentage of total revenue,
We expect our technology and content expenses to increase in absolute dollars due to our increased focus on technology development, including the enhancement of our ecommerce platform.
The following table presents our general and administrative expenses for the years ended December 31, 2004, 2005 and 2006 and dollar and percentage change from the prior year (dollars in thousands):
General and administrative expenses increased by $1.7 million, or 32%, in 2005 compared to 2004. The largest portion of this increase, $0.8 million, related to increased compensation and related expenses associated with an increase in personnel in our finance and legal departments. Expenses for outside professional services associated with our accounting, legal and internal information technology departments increased by $0.7 million during 2005 due to growth in our operations and process improvements in preparation for future operation as a public company. As a percentage of our total revenue, general and administrative expenses remained relatively stable at 17% and 18% in 2005 and 2004, respectively.
Other income, net, primarily consists of interest income earned on cash and cash equivalent balances, offset by administrative bank fees and interest expense on our capital lease obligations. Other income, net, increased $1.1 million, or 455%, in 2006 compared to 2005 and increased $0.2 million, or 298%, in 2005 compared to 2004. These increases were primarily due to an increase in interest income as a result of an increase in our cash and cash equivalents. Cash and cash equivalents increased in 2006 from 2005 primarily as a result of the proceeds we received from our initial public offering in October 2006 and from cash generated from operations during 2006. Cash and cash equivalents increased in 2005 from 2004 primarily from cash generated from operations during 2005. Additionally, the average yield earned on our invested cash and cash equivalent balances increased during 2006 compared to 2005 and in 2005 compared to 2004.
The following table presents our provision (benefit) for income taxes for the year ended December 31, 2004, 2005 and 2006 and the dollar change from the prior year (dollars in thousands):
Our future effective income tax rate will depend on various factors, such as the amount of stock-based compensation we record during the year, potential limitations on the use of our federal and state net operating loss credit carryforwards, pending or future tax law changes including rate changes and the tax benefit from research and development credits, changes in our valuation allowance and state and foreign taxes.
The following table presents a summary of our cash flows for the years ended December 31, 2004, 2005 and 2006 (in thousands):
We completed an initial public offering in October 2006 in which we issued and sold 5,750,000 shares of our common stock, including 750,000 shares sold by us pursuant to the underwriters’ full exercise of their over-allotment option, at an issuance price to the public of $14.00 per share. As a result of our initial public offering, we raised a total of $80.5 million in gross proceeds, or approximately $70.2 million in net proceeds after deducting underwriting discounts and commissions of $5.7 million and offering expenses of $4.6 million. Upon the closing of our initial public offering, all outstanding shares of our convertible preferred stock and Class A nonvoting common stock automatically converted into shares of our common stock.
Our operating activities generated cash of $2.6 million during the year ended December 31, 2005, primarily due to $1.1 million of non-cash depreciation and amortization expenses, $0.2 million of non-cash stock-based compensation expense, $0.2 million of deferred rent expense, a $0.6 million increase in accrued compensation and benefits, a $0.5 million increase in deferred revenue, primarily related to a single health insurance carrier whose commission revenue we deferred during 2005 due to our inability to estimate an allowance for forfeitures and $0.2 million increases in both accounts payable and other current liabilities. These items were partially offset by a net loss of $0.4 million.
Our operating activities used cash of $0.6 million during the year ended December 31, 2004 due to a net loss of $3.3 million, partially offset by $1.5 million of non-cash depreciation and amortization expenses, a $0.5 million increase in accrued compensation and benefits, a $0.4 million increase in accrued marketing expenses, a $0.3 million increase in accounts payable and a $0.2 million decrease in prepaid expenses and other current assets.
The timing of the recognition of our commission revenue depends upon the timing of our receipt of commission reports and associated commission payments from health insurance carriers. If we were to experience a delay in receiving a commission payment from a health insurance carrier at the end of a quarter, our operating cash flows for that quarter could be negatively impacted. Additionally, commission override payments are reported to us in a more irregular pattern than premium commissions. For example, a carrier may make a commission override payment to us on an annual basis, which would positively impact our cash flows in the quarter the payment is received. The majority of our annual commission override payments are typically received during the first quarter of the year.
Cash provided by financing activities of $71.7 million during the year ended December 31, 2006 was primarily due to $74.8 million in proceeds received from our initial public offering, plus $0.5 million of net proceeds received from the issuance of common stock pursuant to stock option exercises, partially offset by $3.3 million of costs incurred in connection with our initial public offering and $0.2 million in principal payments on capital leases. Cash used in financing activities of $0.7 million during the year ended December 31, 2005 was primarily due to $1.0 million of costs incurred in connection with our initial public offering, less proceeds received from the issuance of common stock pursuant to stock option exercises of $0.4 million. Cash provided by financing activities of $0.2 million during the year ended December 31, 2004 was primarily attributable to proceeds received from the issuance of common stock pursuant to stock option exercises.
We believe that cash generated from operations and our current cash, cash equivalents and investments will be sufficient to fund our operations for at least the next 12 months. Our future capital requirements will depend on many factors, including our level of investment in technology and advertising initiatives. Although we are currently not a party to any agreement or letter of intent with respect to investments in, or acquisitions of, complementary businesses, products or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Aside from capital lease obligations, we currently do not have any bank debt, line of credit facilities or other borrowing arrangements. To the extent that
The following table presents a summary of our future minimum payments under non-cancellable operating lease agreements and certain contractual obligations and commitments as of December 31, 2006 (in thousands):
In August 2004, we entered into a lease agreement for our headquarters building in Mountain View, California. This facility is leased under a non-cancellable lease that expires in 2009, with a renewal option at fair market value for an additional five-year period. In December 2004, we moved our customer care center from Folsom, California to Gold River, California and entered into a non-cancellable sixty-five month lease which expires in 2010. In December 2005, we leased additional space in the same facility in Gold River, California under a separate fifty-four month lease which expires in 2010. We entered into a non-cancellable office lease for our subsidiary in China which commenced in April 2006 and is for a term of one year and automatically renews for one-year periods, up to a total term of five years. During June 2006, we also entered into a non-cancellable lease for our data center in San Jose, California. The lease, which commenced in August 2006, is for a term of three years. In September 2006, we entered into a non-cancellable office lease for an additional facility in Mountain View, California. The lease commenced in December 2006 and is for a term of three years. We also lease other facilities in the United States under non-cancellable operating leases that range in terms up to one year. Certain of these leases have free or escalating rent payment provisions. We recognize rent expense on our operating leases on a straight-line basis over the terms of the leases. In addition, we lease equipment under operating leases that range in terms from three to five years, the latest of which expires in August 2009.
As of December 31, 2006, we had a capital lease obligation for office equipment, which expires in December 2007, and a second capital lease obligation, which expires in July 2007, for computer equipment related to our data center.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of eHealth, Inc. at December 31, 2005 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
Description of Business-eHealth, Inc. and subsidiaries (“the Company,” “we” or “us”), offer Internet-based insurance agency services for individuals, families and small businesses in the United States. Our services enable individuals, families and small businesses to research, analyze, compare and purchase health insurance products from health insurance carriers across the nation. We are licensed to market and sell health insurance in all 50 states and the District of Columbia.
Initial Public Offering-In October 2006, we completed an initial public offering (“IPO”) of our common stock in which we issued and sold 5,750,000 shares of our common stock, including 750,000 shares sold by us pursuant to the underwriters’ full exercise of their over-allotment option, at an issuance price of $14.00 per share. As a result of our IPO, we raised a total of $80.5 million in gross proceeds, or approximately $70.2 million in net proceeds after deducting underwriting discounts and commissions of $5.7 million and offering expenses of $4.6 million. Upon the closing of our IPO, all outstanding shares of our previously outstanding convertible preferred stock and Class A nonvoting common stock automatically converted into 10,955,744 and 36,603 shares of common stock, respectively. The consolidated financial statements for the year ended December 31, 2006, including share and per share amounts, include the effects of the offering.
Reverse Stock Split-We effected a 1-for-2 reverse stock split of our outstanding common stock, convertible preferred stock and Class A nonvoting common stock on September 25, 2006. All share and per share amounts contained in the consolidated financial statements have been retroactively adjusted to reflect the reverse stock split.
Cash Equivalents-We consider all highly liquid investments with an original maturity of three months or less from the date of purchase to be cash equivalents. Cash and cash equivalents, which primarily consist of cash on deposit with banks and money market funds, are stated at cost, which approximates fair value.
Restricted Investments-Restricted investments consisted of two certificates of deposit, and the interest receivable thereon, securing letters of credit, which acted as collateral for certain of our operating leases. The letters of credit, which totaled $138,000 at December 31, 2005, were surrendered by the beneficiary during 2006, and accordingly, these certificates of deposit were classified as short-term investments at December 31, 2006.
Prepaid Expenses and Other Current Assets-Prepaid expenses and other current assets consists of prepaid insurance, interest receivable on invested cash and other prepaid expenses and non-trade receivables.
Property and Equipment-Property and equipment are stated at cost, less accumulated depreciation and amortization. Capital lease amortization expenses are included in depreciation expense in our consolidated statements of operations and comprehensive income (loss). Depreciation is computed using the straight-line method based on estimated useful lives as follows:
Intangible Assets-In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, intangible assets determined to have an indefinite useful life are not
Long-Lived Assets-In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we evaluate other long-lived assets for impairment on a periodic basis or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. No long-lived assets were deemed impaired during the three-year period ended December 31, 2006.
Fair Value of Financial Instruments-The carrying amounts of our financial instruments, including cash and cash equivalents, investments, accounts receivable, accounts payable and accrued liabilities (including accrued compensation and benefits, accrued marketing expenses and other current liabilities), approximate fair value because of their short maturities. The carrying amounts of our capital leases approximate the fair value of these obligations based upon our best estimates of interest rates that would be available for similar debt obligations at December 31, 2005 and 2006.
Revenue Recognition-We recognize revenue for our services using the criteria set forth in Staff Accounting Bulletin (“SAB”) No. 104 (“SAB 104”), Revenue Recognition. SAB 104 states that revenue is recognized when each of the following four criteria is met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the seller’s price to the buyer is fixed or determinable; and collectibility is reasonably assured.
Our revenue is primarily comprised of compensation paid to us by health insurance carriers related to insurance policies that have been purchased by a member who used our service. We define a member as an individual currently covered by an insurance product for which we are entitled to receive compensation. Our compensation generally represents a percentage of the premium amount collected by the carrier during the period
We recognize commission revenue when our commission is reported to us by a health insurance carrier, net of an allowance for future forfeiture amounts payable to carriers due to policy cancellations. Commissions are reported to us by a cash payment and commission statement. We generally receive these communications simultaneously. In instances when we receive the cash payment and commission statement separately and in different accounting periods, we recognize revenue in the period that we receive the earliest communication, provided we receive the second communication corroborating the amount reported in the first communication within ten business days. If the second corroborating communication is not received within ten business days, we recognize revenue in the period the second communication is received. We use the data in the commission statement to identify the members for which we are receiving a commission payment and the amount received for each member, and to estimate our allowance for forfeitures.
us or based on data that is tracked by the third party. In instances where the performance criteria data is tracked by us, we recognize revenue in the period of performance. In instances where the performance criteria data is tracked by the third party, we recognize revenue when the amounts earned are both fixed and determinable and collection is reasonably assured. Typically, this occurs through our receipt of a cash payment from the third party along with a detailed statement containing the data that is tracked by the third party.
Cost of Revenue-Sharing-Cost of revenue-sharing consists primarily of payments related to health insurance policies sold to members who were referred to our website by marketing partners with whom we have revenue-sharing arrangements. In accordance with EITF No. 01-9, Accounting for Consideration Given by a Vendor to a Customer (including a Reseller of the Vendor’s Products), costs related to revenue-sharing arrangements are expensed at the time the related revenue is recognized. Included in cost of revenue-sharing for 2006 was $268,000 of revenue-sharing expense related to commission revenue we recognized during the year associated with a partner who is in the process of transferring certain small business members to us and with whom we share a percentage of the ongoing commissions we receive on these transferred policies.
Our direct channel expenses primarily consist of offline marketing and associated costs. We generally compensate our marketing partners by paying a one-time fee each time a consumer referral from a partner results in a submitted health insurance application on our ecommerce platform, regardless of whether the consumer’s application is approved by the health insurance carrier. We recognize these expenditures in the period when a marketing partner’s referral results in the submission of a health insurance application on our website. Paid keyword search advertising on search engines represents the majority of expenses in our online advertising channel. We incur expenses associated with search engine advertising in the period in which the consumer clicks on the advertisement.
Customer Care and Enrollment-Customer care and enrollment expenses consist of compensation and related expenses for personnel engaged in pre-sales assistance to applicants who call our customer care center and enrollment personnel who assist applicants during the underwriting process.
Technology and Content-Technology and content expenses consist primarily of compensation and related expenses for personnel associated with developing and enhancing our website technology as well as maintaining our website.
Software Developed for Internal Use-In accordance with Statement of Position (“SOP”) No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, and EITF Issue No. 00-2, Accounting for Web Site Development Costs, we capitalize costs of materials, consultants and compensation and related expenses of employees who devote time to the development of internal-use software during the application development stage. We expense costs incurred for preliminary project assessment, research and development, re-engineering, training and application maintenance activities. As of December 31, 2005, the net book value of capitalized internal-use software totaled $90,000. At December 31, 2006, our capitalized internal-use software was fully depreciated and had a net book value of zero. We recorded $121,000, $121,000 and $90,000 of depreciation expense related to capitalized internal-use software for the years ended December 31, 2004, 2005 and 2006, respectively.
Stock-Based Compensation-Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, Share-Based Payment (“SFAS 123R”), which requires us to measure the cost of employee services received in exchange for an award of equity instruments, based on the fair value of the award on the date of grant, and to recognize the cost over the period during which the employee is required to provide services in
Foreign Currency Translation-The functional currency of our only foreign subsidiary is its local currency. The financial statements of our foreign subsidiary are translated into U.S. Dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenues, costs and expenses. Translation adjustments are reflected in accumulated other comprehensive income in the accompanying consolidated balance sheets, while gains and losses resulting from foreign currency transactions are included in other income, net in the accompanying consolidated statements of operations and comprehensive income (loss). We did not recognize any material gains or losses resulting from foreign currency transactions during the years ended December 31, 2004, 2005 or 2006.
Net Income (Loss) Per Share-We calculate net income (loss) per share in accordance with SFAS No. 128, Earnings Per Share (“SFAS 128”). Under SFAS 128, basic net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding for the period (excluding
shares subject to repurchase). Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted-average number of common and common equivalent shares outstanding during the
Recent Accounting Pronouncement-In September 2006, the FASB issued SFAS No. 157 (“SFAS 157”), Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. The measurement and disclosure requirements are effective for us beginning January 1, 2008. We are currently assessing whether adoption of SFAS 157 will have a material impact on our financial statements.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 provides interpretive guidance on how to evaluate the materiality of uncorrected misstatement in the current year financial statements using both an income statement approach (the rollover approach) and a balance sheet approach (the iron curtain approach). The rollover approach quantifies a misstatement based on the amount of the error originating in the current year income statement while the iron curtain approach quantifies a misstatement based on the effects of correcting the cumulative misstatement existing in the balance sheet at the end of the current year. SAB 108 is effective for periods beginning after November 15, 2006. We do not expect the adoption of SAB 108 to have a material effect on our financial position or results of operations.
Cash, cash equivalents and investments consisted of the following (in thousands):
We did not experience any significant realized gains or losses on our investments in the periods presented. Gross unrealized gains and losses at December 31, 2005 and 2006 were not material.
Assets under capital leases were included in the consolidated balance sheets as follows (in thousands):
After the completion of our initial public offering and the filing of our amended and restated certificate of incorporation, the board of directors has the authority, without any further action by our stockholders, to issue up to 110,000,000 shares, par value $0.001 per share, of which 10,000,000 shares are designated as preferred stock. The board of directors has the authority to issue preferred stock in one or more series and to fix the number of shares, designations, preferences, powers, and rights and the qualification, limitations or restrictions thereof. The preferences, powers, rights and restrictions of different series of preferred stock may differ with respect to dividend rates, amounts payable on liquidation, voting rights, conversion rights, redemption provisions, sinking fund provisions and other matters. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to holders of common stock or adversely affect the rights and powers, including voting rights, of the holders of common stock, and may have the effect of delaying, deferring or preventing a change in control of our company. At December 31, 2006, no shares of preferred stock were outstanding.
During 2000 and 2001, we entered into a series of marketing agreements with various partners, in which we issued warrants to purchase an aggregate of 167,544 shares of our Series B convertible preferred stock at $19.86 per share and 73,750 shares of our Series C convertible preferred stock at $5.74 per share. The warrants were generally exercisable upon issuance or upon the achievement of certain milestones. During 2003, we issued
5,000 shares of Series C convertible preferred stock in connection with the exercise of a warrant for total proceeds of $29,000. All warrants expired unexercised prior to December 31, 2005.
Class A Nonvoting Common Stock-As of December 31, 2005, we had authorized 1,600,000 shares of Class A nonvoting common stock, $0.001 par value per share. Each share of Class A nonvoting common stock had the same rights as our common stock, except each share of Class A nonvoting common stock is nonvoting and, in accordance with a resolution adopted by our board of directors on May 3, 2006, would automatically convert into one-eighth of one share of our common stock upon the closing of a firmly underwritten public offering of our common stock pursuant to a registration statement on Form S-1 under the Securities and Exchange Act of 1933, as amended. In connection with our IPO in October 2006, all shares of Class A nonvoting common stock converted into 36,603 shares of common stock
Common Stock Warrants-During 2000, we entered into a marketing agreement with a partner in which we issued a warrant to purchase an aggregate of 12,500 shares of our common stock at $2.00 per share. The warrant, which was exercisable upon issuance, expired unexercised during December 2005. We recorded marketing and advertising expense totaling $1,000 during each of the years ended December 31, 2004 and 2005 relating to this warrant. No ongoing expense was recognized related to this warrant subsequent to December 31, 2005.
Shares Reserved-Shares of authorized but unissued common stock reserved for future issuance were as follows (in thousands):
Our stock options and restricted stock awards granted under the 2006 Plan and the 1998 and 2005 Stock Plans (collectively, the “Stock Plans”) generally vest over four years at a rate of 25% after one year and 1/48th per month thereafter. Our stock options generally expire after ten years from the date of grant. Options granted prior to our IPO in October 2006 typically may be exercised at any time, with unvested shares issued upon exercise being subject to repurchase rights by us at the exercise price of the stock option. As of December 31, 2005 and 2006, no shares were subject to repurchase.
Shares of common stock subject to restricted common stock awards under the Stock Plans issued during the year ended December 31, 2003 were subject to a forfeiture condition that lapsed 25% after the first year of service and ratably each month over the subsequent 36 months, contingent upon the grantee continuing to provide services to us. No restricted common stock awards under the Stock Plans were issued during the years ended December 31, 2004, 2005 and 2006. As of December 31, 2004, 2005 and 2006, 8,000, 4,500 and 1,700, respectively, shares of restricted common stock awarded under the Stock Plans were subject to forfeiture.
Pursuant to the terms of a May 2003 stock option granted to one of our executive officers, upon a change in control, the officer immediately becomes vested in 50% of the remaining unvested shares subject to the option. If the officer is terminated without cause following the change in control, he becomes vested in any remaining
unvested shares subject to the option, provided that he signs a general release of claims. As these vesting acceleration provisions are provided in the original terms of stock option agreements, no additional stock-based compensation was or will be recognized related to these provisions.
During 2006, the board of directors approved the granting of restricted stock units covering 33,256 shares of common stock to employees from the 2006 Plan. These restricted stock units were issued at the grant-date fair value of $21.25 per unit, and vest over four years at a rate of 25% per year.
The following table summarizes stock option activity under the Stock Plans (in thousands, except per share amounts):
(3) The 1998 and 2005 Stock Plans were terminated with respect to the grant of additional shares upon the effective date of the registration statement related to our IPO in October 2006, resulting in a reduction in the number of authorized shares.
(4) The 2006 Plan became effective in October 2006 upon the effective date of the registration statement related to our IPO.
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the fair value of our common stock at December 31, 2006 for the 5.3 million options that were in-the-money at December 31, 2006. Total intrinsic value of stock options exercised during the year ended December 31, 2006 was $1.9 million. Total fair value of stock options accounted for under SFAS 123R, which vested during the year ended December 31, 2006 was zero. The per share weighted-average fair value of stock options granted during the year ended December 31, 2006 was $15.39.
The following table summarizes restricted stock unit activity under the Stock Plans (in thousands, except weighted-average remaining contractual life data):
As of December 31, 2006, none of the restricted stock units had vested.
We account for Class A nonvoting common stock awards granted subsequent to January 1, 2006 in accordance with the provisions of SFAS 123R. During the year ended December 31, 2006, we recorded $13,000 of stock-based compensation expense related to these awards. As of December 31, 2006, total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the eHealth China Plan and accounted for under SFAS 123R was $67,000, net of estimated forfeitures of $7,000. This cost will be recognized over a weighted-average period of 3.3 years.
conversion of Class A nonvoting common stock into common stock, we accounted for awards granted under the eHealth China Plan prior to January 1, 2006 as variable awards. Under this method, we recorded no deferred stock-based compensation, but measured and recorded stock-based compensation expense based on the fair value of the underlying Class A nonvoting common stock at the end of each reporting period within the vesting periods. Upon the completion of our IPO in October 2006, all unvested shares of Class A nonvoting common stock issued prior to January 1, 2006 were converted into shares of common stock measured at the fair value public offering price of $14.00 per share and, in accordance with APB 25, we recorded deferred stock-based compensation totaling $255,000, which will be amortized over the remaining vesting terms of the underlying common stock. During the years ended December 31, 2005 and 2006, we recorded $49,000 and $108,000, respectively, of stock-based compensation expense related to these awards. As of December 31, 2006, the remaining unamortized deferred stock-based compensation totaled $230,000 related to these awards.
Stock Awards and Stock Options Granted to Non-Employees-During the year ended December 31, 2004, we issued options to purchase 13,125 shares of common stock with a weighted-average exercise price of $4.00 to non-employees and during the year ended December 31, 2005, we issued options to purchase 500 shares of common stock with a weighted-average exercise price of $8.00 to a non-employee. No stock options were issued to non-employees during the year ended December 31, 2006.
The compensation cost of these arrangements is determined using the fair value method and is subject to remeasurement over the vesting terms as equity instruments are being earned. The weighted-average assumptions for the Black-Scholes-Merton pricing model used in determining the fair value of stock options granted to non-employees were as follows:
We recorded stock-based compensation expense of $18,000 and $3,000 during the years ended December 31, 2004 and 2005, respectively, related to the stock options granted to non-employees under our stock plans. The amount recorded for the year ended December 31, 2005 related to services performed by a consultant in connection with our initial public offering; therefore, the amount was included in deferred initial public offering costs in the accompanying consolidated balance sheets. No stock-based compensation expense was recognized related to these options during the year ended December 31, 2006.
The following table summarizes stock-based compensation expense recorded during the years ended December 31, 2004, 2005 and 2006 (in thousands):
Pro Forma Stock-Based Compensation Expense-Had compensation cost for all options granted to our employees under our stock-based compensation plans been determined based on the fair value method prescribed by SFAS 123 during the years ended December 31, 2004 and 2005, our net loss and net loss per share would have been adjusted to the pro forma amounts as follows (in thousands, except per share amounts):
For purposes of the above pro forma calculation, the fair value of each option granted during the years ended December 31, 2004 and 2005 was estimated on the date of grant using the minimum value method with the following weighted-average assumptions:
All options granted during the years ended December 31, 2004 and 2005 were granted with an exercise price equal to the fair value at the time of grant.
At December 31, 2006, total unrecognized stock-based compensation expense related to stock options, restricted stock and restricted stock units granted to employees under our stock plans and accounted for in accordance with SFAS 123R was approximately $3.6 million, net of estimated forfeitures of $383,000. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 3.5 years and will be adjusted for subsequent changes in estimated forfeitures.
The following table presents stock-based compensation expense and total unrecognized stock-based compensation expense related to stock options, restricted stock and restricted stock units granted to employees during the year ended December 31, 2006 and accounted for in accordance with SFAS 123R (in thousands):
Net cash proceeds from the exercise of stock options were $476,000 for the year ended December 31, 2006. No income tax benefits were realized from stock option exercises during the year ended December 31, 2006. In accordance with SFAS 123R, we present excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows.
We estimate the fair value of stock options granted using the Black-Scholes-Merton pricing model and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The weighted-average expected term for stock options granted during the year ended December 31, 2006 was calculated using the simplified method in accordance with the provisions of SAB No. 107, Share-Based Payment. The simplified method defines the expected term as the average of the contractual term and the vesting period of the stock option. We have estimated the volatility and forfeiture rates used as inputs to the model based on an analysis of our stock price since our IPO in October 2006, as well as an analysis of the most similar public companies for which we have data. We have used judgment in selecting these companies, as well as evaluating our available historical and implied volatility and forfeiture data and the data for these companies. The dividend yield is determined by dividing the expected per share dividend during the coming year by the grant date stock price. Through December 31, 2006, we had not declared or paid any cash dividends. We base the risk-free interest rate on the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of our stock options.
In September 1998, our board of directors adopted a defined contribution retirement plan (401(k) Plan), which qualifies under Section 401(k) of the Internal Revenue Code of 1986. Participation in the 401(k) Plan is available to substantially all employees in the United States. Employees can contribute up to 25% of their salary, up to the federal maximum allowable limit, on a before-tax basis to the 401(k) Plan. Employee contributions are fully vested when contributed. Company contributions to the 401(k) Plan are discretionary and are expensed when incurred. We did not make any matching contributions to the 401(k) Plan through December 31, 2005.
The following table provides a reconciliation of the federal statutory income tax rate to our effective tax rate for the years ended December 31, 2004, 2005 and 2006:
and the current year realization of previously deferred tax assets resulted in a net reduction in the valuation allowance of $9.9 million during the year ended December 31, 2006. The valuation allowance was increased by approximately $1.3 million and $139,000 during the years ended December 31, 2004 and 2005, respectively, due to significant doubt regarding the recoverability of the deferred tax assets at those dates.
Deferred tax liabilities have not been recognized for undistributed earnings from our China subsidiary because it is management’s intention to indefinitely invest such undistributed earnings in our China subsidiary. Undistributed earnings from our China subsidiary totaled approximately $146,000 at December 31, 2006. If we distribute those earnings, in the form of dividends or otherwise, we would be subject to both U.S. federal income taxes (net of applicable foreign tax credits) and withholding taxes payable in China.
Income from our China subsidiary is subject to reduced tax rates due to our commitment to invest $1.0 million in its operations within the first eighteen months of its operations, which we met during the year ended December 31, 2005. As a result, all of the foreign tax related to income generated by our subsidiary during the years ended December 31, 2004 and 2005 was rebated to us. In addition, we expect that half of the foreign tax related to income generated by our China subsidiary during the years ended December 31, 2006, 2007 and 2008 will be rebated to us. The income tax benefits related to this tax status were estimated to be $5,000, $4,000 and $7,000 for the years ended December 31, 2004, 2005 and 2006, respectively.
For each years ended December 31, 2004, 2005 and 2006, we had securities outstanding that could potentially dilute earnings per share, but the incremental shares from the assumed conversion or exercise of these securities were excluded in the computation of diluted net income (loss) per share as their effect would have been anti-dilutive.
As of December 31, 2005, we had a capital lease obligation related to office equipment, which expires in December 2007. During August 2006, we entered into a second capital lease obligation that expires in July 2007 for computer equipment related to our new data center.
In the ordinary course of our business, we have received and may continue to receive inquiries from state regulators relating to various matters from time to time, including the order from the Office of the Insurance Commissioner of the State of Washington. We may also become involved in litigation in the future in the ordinary course of our business. If we are found to have violated laws or regulations in the state of Washington or in other states, we could be subject to various fines and penalties, including revocation of our license to sell insurance in those states, and our business and financial results would be harmed. We would also be harmed to the extent that related publicity damages our reputation as a trusted source of objective information relating to health insurance and its affordability. It could also be costly to defend ourselves regardless of the outcome.
Geographic Information-We generate revenue solely in the United States. As of December 31, 2006, our long-lived assets consisted primarily of property and equipment, and as of December 31, 2005, our long-lived assets consisted primarily of property and equipment and deferred initial public offering costs. Our long-lived assets are attributed to the geographic location in which they are located. Long-lived assets by geographical area were as follows (in thousands):