We are the leading online source of health insurance for individuals, families and small businesses. Through our website addresses (www.eHealth.com, www.eHealthInsurance.com, www.eHealthMedicare.com and www.PlanPrescriber.com), consumers can get quotes from leading health insurance carriers, compare plans side-by-side, and apply for and purchase individual and family, Medicare-related, small business, short-term and ancillary health insurance plans. Our ecommerce technology also enables us to deliver consumers’ health insurance applications electronically to health insurance carriers. As a result, we simplify and streamline the complex and traditionally paper-intensive health insurance sales and purchasing process.
We began actively marketing the availability of Medicare-related health insurance plans during 2010 through our online Medicare plan platforms (www.eHealthMedicare.com and www.PlanPrescriber.com). In April 2010, we acquired PlanPrescriber, Inc., a privately-held provider of online tools to help Medicare-eligible individuals navigate Medicare health insurance options. Our Medicare plan platforms enable consumers to research and compare Medicare-related health insurance plans, including Medicare Advantage, Medicare Supplement and Medicare Part D prescription drug plans. Commission payments we receive for Medicare Advantage and Medicare Part D prescription drug plans sold by us are typically fixed and are earned over a period of up to six years, or longer depending on the carrier arrangement, and are paid to us either monthly or annually. Medicare commissions we receive are included in commission revenue.
As a result of our commission structure, much of our revenue for a given financial reporting period relates to health insurance plans that we sold prior to the beginning of the period and is recurring in nature. Additionally, health insurance pricing, which is set by the health insurance carrier and approved by state regulators, is not subject to negotiation or discounting by health insurance carriers or our competitors.
improve health care quality and, if they do not, to provide rebates to policyholders. While many aspects of health care reform do not become effective until 2014, health insurance carriers have been required to maintain medical loss ratios of eighty percent in their individual and family health insurance business since the beginning of 2011. The implementation of the medical loss ratio requirements by insurance carriers has resulted in a reduction in the commission rates that we are paid as a result of our selling individual and family health insurance plans. These commission rate changes began to impact our individual and family health insurance plan commission-based revenue in 2011.
We derive revenue from our online sponsorship advertising program that allows carriers to purchase advertising space in specific markets in a sponsorship area on our website. In return, we are typically paid a monthly fee and a performance-based fee based on metrics such as submitted health insurance applications. We also offer Medicare sponsorship services, which allow Medicare plan carriers to purchase advertising on a separate website developed, hosted and maintained by us. In these instances, we are typically paid a fixed, up-front fee, which we recognize as revenue over the service period.
The Medicare revenue we have generated also includes referral fees paid to us based on Medicare leads generated by our online platforms that are delivered and sold to third parties. Although we expect to continue to sell Medicare leads to third parties in the future, we intend to perform services for an increasing number of our Medicare leads ourselves as a health insurance agent. To the extent that we do so, we will be entitled to receive commissions rather than a one-time referral fee.
We generate revenue primarily from commissions we receive from health insurance carriers whose health insurance policies are purchased through us. Commissions for individual, family and small business health insurance policies sold by us generally represent a percentage of the insurance premium and, to a much lesser extent, commission override payments that insurance carriers pay us 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 can vary based upon the amount of time that the policy has been active, with commission rates for individual and family plans typically being higher in the first twelve months of the policy. After the first twelve months, commission rates generally decline significantly. As a result, if we do not add a sufficient number of members on new policies, our revenue growth will be negatively impacted. Individuals, families and small businesses purchasing health insurance through us typically pay their premiums on a monthly basis. Insurance carriers typically pay commissions to us on these policies monthly, after they receive the premium payment from the member. We generally 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 commission revenue is recurring in nature.
We began actively marketing the availability of Medicare-related insurance plans during 2010 through our online Medicare plan platforms (www.eHealthMedicare.com and www.PlanPrescriber.com). These platforms enable consumers to research and compare Medicare-related insurance plans, including Medicare Advantage, Medicare Supplement and Medicare Part D prescription drug plans. Beginning in the fourth quarter of 2010, we began to offer online application capabilities for certain Medicare plans and, through our customer care centers in Gold River, California, Salt Lake City, Utah and Maynard, Massachusetts, we offer telephonic enrollment capabilities for Medicare-related insurance plans as well as other health insurance plans, including individual and family health insurance plans. To the extent that we assist in the sale of Medicare-related insurance plans as a health insurance agent, through either online applications or telephonically, we generate revenue from commissions we receive from health insurance carriers. The commission payments we receive for Medicare Supplement plans are typically a percentage of the premium on the policy that we sold and are paid to us on a monthly basis for as long as a policy remains active with us. For both Medicare Advantage and Medicare Part D prescription drug plans, we receive a fixed, annual commission from insurance carriers once the policy is approved by the carrier and either a fixed, monthly commission beginning with and subsequent to the second policy year for a Medicare Advantage policy or a fixed, annual commission beginning with and subsequent to the second policy year for a Medicare Part D prescription drug policy. We may earn commission revenue for both Medicare Advantage and Medicare Part D prescription drug plans typically for a period of up to six years, or longer depending on the carrier arrangement, provided that the policy remains active with us.
In addition to the commission revenue we derive from the sale of health insurance plans, we derive other revenue from generating and delivering leads, primarily for Medicare plans, from licensing the use of our ecommerce technology and from our online sponsorship and advertising program.
on a separate website developed, hosted and maintained by us. In these instances, we are typically paid a fixed, up-front fee, which we recognize as revenue over the service period.
We expect other revenue to be similar in absolute dollars in 2012 compared to 2011.
Direct. Our direct member acquisition channel consists of consumers who access our website addresses (www.eHealth.com, www.eHealthInsurance.com, www.eHealthMedicare.com and www.PlanPrescriber.com) either directly or through algorithmic natural search listings on Internet search engines and directories. For the years ended December 31, 2009, 2010 and 2011, applications submitted through us for individual and family health insurance from our direct channel constituted 42%, 43% and 44%, respectively, of all individual and family health insurance applications submitted on our website.
through us for individual and family health insurance plans from our marketing partner member acquisition channel constituted approximately 32%, 29% and 32%, respectively, of all individual and family health insurance applications submitted on our website.
In additional to our member acquisition channels, we have acquired both individual and family plan and Medicare plan members through agreements with certain business development partners, whereby these partners have transferred certain of their existing individual and family plan and Medicare plan members to us as the broker of record on the underlying policies.
Cost of revenue also includes direct labor and other direct costs incurred in connection with our government systems activities. Initial direct labor and other direct costs incurred prior to the availability of our technology for use by a government agency were deferred and included in prepaid expenses and other current assets in our consolidated balance sheet and were amortized to cost of revenue from the date our technology was available for use by the government agency in October 2010 to the end of the initial one-year term of the contract in July 2011. Direct labor and other direct costs incurred subsequent to the availability of our technology for use by the government agency are recognized as cost of revenue as incurred. The term of this contract expired in January 2012.
Additionally, cost of revenue includes the amortization of consideration we paid to certain brokers in connection with the transfer of their health insurance members to us as the new broker of record on the underlying policies. These transfers have included both individual and family plan members as well as Medicare plan members. In November 2010, we entered into an agreement with a partner, whereby the partner transferred certain of its existing Medicare plan members to us as the broker of record on the underlying policies for arrangement consideration totaling $3.3 million. In May 2011 and October 2011, we entered into similar agreements with the same partner, whereby the partner transferred certain of its existing Medicare plan members to us as the broker of record on the underlying policies. Total consideration was $3.1 million and $1.2 million for the May 2011 and October 2011 arrangements, respectively. All book of business transfers are being amortized to cost of revenue as we recognize commission revenue related to the transferred members over a period of up to five years for each arrangement.
We expect our marketing and advertising expenses to increase in absolute dollars in 2012 compared to 2011 due to an increase in our Medicare-related online marketing and advertising expenditures during 2012, including paid keyword search advertising.
customer care centers to service the increase in the volume of Medicare leads we received in the fourth quarter of 2011 as a result of the Medicare annual enrollment period. Most of these additional customer care center employees were temporary and their employment ended after the conclusion of the Medicare annual enrollment period in December 2011. As a result of our temporary customer care center staffing requirements, we expect our customer care and enrollment costs to be higher in the third and fourth quarters of each year compared to the first and second quarters. Because the majority of our Medicare plan-related revenue is not generated until the fourth quarter, our temporary customer care center staffing costs incurred in the third quarter have had a significant negative impact on our profitability during the third quarter. We expect this seasonal pattern to occur in 2012.
We expect customer care and enrollment expenses to increase in absolute dollars in 2012 compared to 2011 as a result of additional personnel we expect to hire to service the expected increase in the volume of Medicare demand in 2012 and due to an increase in expenditures to develop and expand our Medicare plan sales capabilities.
We expect technology and content expenses to remain relatively flat in absolute dollars in 2012 compared to 2011.
We expect our general and administrative expenses to decline in 2012 compared to 2011 due primarily to a decrease in government affairs expenses.
Intangible assets with finite useful lives, which include acquired technology, acquired pharmacy and customer relationships, trade names, trademarks and website addresses, are amortized over their estimated useful lives and are reviewed for impairment when facts or circumstances suggest that the carrying value of these assets may not be recoverable. As a result of the streamlining of a legacy software product, we assessed the impairment of an intangible asset in the fourth quarter of 2011 and, as a result, we recorded an impairment charge of $0.3 million related to the intangible asset. The impairment charge is included in amortization of intangible assets on the consolidated statements of income and comprehensive income.
(2) IFP applications submitted on eHealth’s website during the period. Applications are counted as submitted when the applicant completes the application, provides a method for payment and clicks the submit button on our website and submits the application to us. The applicant generally has additional actions to take before the application will be reviewed by the insurance carrier, such as providing additional information and providing an electronic signature. In addition, an applicant may submit more than one application. We include applications for IFP plans for which we receive commissions as well as other forms of payment. We define our “IFP” offerings as major medical individual and family health insurance plans, which does not include small business, short-term, stand-alone dental, life, student or Medicare-related health insurance plans.
(6) Calculated as commission revenue recognized during the period (see note (5) above) divided by average estimated membership for the period (calculated as beginning and ending estimated membership for all plans for the period, divided by two).
(7) Total revenue (from all sources) recognized during the period from the consolidated statements of operations.
(9) Estimated number of members active on IFP insurance policies as of the date indicated.
(10) Estimated number of members active on all insurance policies, including Medicare policies, as of the date indicated.
(11) Marketing and advertising expenses for the period from the consolidated statements of operations.
The discussion and analysis of our consolidated financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amount of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to, but not limited to, estimates for commission forfeitures, the assumptions used in determining stock-based compensation, the useful lives of intangible assets, fair value of intangible assets, goodwill, valuation allowance for deferred income taxes and provision for income taxes. We base our estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that we believe to be reasonable and historically consistent. In many cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results may differ materially from these estimates.
For both Medicare Advantage and Medicare Part D prescription drug plans, we receive a fixed, annual commission payment from insurance carriers once the policy is approved by the carrier and either a fixed, monthly commission payment beginning with and subsequent to the second policy year for a Medicare Advantage policy or a fixed, annual commission payment beginning with and subsequent to the second policy year for a Medicare Part D prescription drug policy. We recognize commission revenue for both Medicare Advantage and Medicare Part D prescription drug plans for the entire policy year once the annual or first monthly commission amount for the policy year is reported to us by the carrier, net of an estimate for future forfeiture amounts due to policy cancellations. For commissions paid to us on a monthly basis, we will a receivable for the commission amounts to be received over the remainder of the policy year, net of an estimate for commission amounts not expected to be collected due to policy cancellations, which is included in accounts receivable in the accompanying balance sheets. We continue to receive the commission payments from the relevant insurance carrier until the earlier of our being notified that the health insurance policy has been cancelled, our no longer remaining the agent on the policy, or our commission term with the carrier expires, typically up to six years from the effective date of the policy. We determine that there is persuasive evidence of an arrangement when we have a commission agreement with a health insurance carrier. Our services are complete when a carrier has approved an application in the initial year and when a member has renewed in a renewal year. The seller’s price is fixed or determinable and collectibility is reasonably assured when a carrier has approved an application and the carrier reports to us the annual or first monthly renewal commission amount for each policy year.
Certain commission amounts are subject to forfeiture when the policy is subsequently cancelled and either the carrier takes back all or a portion of the commission they have paid to us or we will no longer receive
monthly commissions payments for the remainder of the policy year. We record an estimate for these forfeitures based on our historical cancellation experience using data provided on commission statements. Policy cancellations and the commission amounts, if any, to be taken back by the carrier are typically reported to us by health insurance carriers several months after the policy’s cancellation date. Our estimate for forfeitures payable to a carrier, which is included in other current liabilities in the accompanying balance sheets, includes an estimate of both the reporting time lag and the forfeiture amount, based on our historical experience by policy type. Similarly, our estimate for commission amounts not expected to be collected due to policy cancellations, which is recorded as a reduction of accounts receivable in the accompanying balance sheets, includes an estimate of the annual policy cancellation rate, based on our historical experience by policy type. Changes in our historical trends would result in changes to our estimated forfeitures in future periods. There were no changes in our average forfeiture rates or reporting time lag during the years ended December 31, 2010 and 2011 which had a material impact on our estimate for forfeitures. We do not expect our estimated forfeiture rates to materially change in 2012 compared to 2011.
fair value for each element within the contract and, therefore, accounted for the entire contract as one unit of accounting. We deferred all revenue related to the contract until our technology was available for use by the federal government. Revenue was recognized on a straight-line basis from the date our technology was available for use by the federal government to the end of the initial one-year term of the contract in July 2011. The term of this contract expired in January 2012.
Medicare Lead Referral Revenue-The Medicare-related revenue we have generated includes referral fees paid to us based on Medicare leads generated by our online platforms that are delivered and sold to third parties. We sell our leads to a limited number of purchasers of our leads, and the majority of our lead referral revenue is generated during the Medicare annual enrollment period, which occurs during the fourth quarter of the calendar year. We recognize lead referral revenue when persuasive evidence of an arrangement exists, delivery of a lead has occurred, the fee is fixed or determinable and collectability is reasonably assured. Delivery is deemed to have occurred at the time a lead is delivered to the customer.
We recognize stock-based compensation expense in the accompanying consolidated statements of income and comprehensive income based on the fair value of our stock-based awards over their respective vesting periods, which is generally four years. The weighted-average expected term for stock options granted during 2011 was calculated using historical option exercise behavior. Prior to 2011, the weighted-average expected term for stock options granted was calculated using the simplified method, as we did not have sufficient historical option exercise behavior on which to estimate expected terms. The simplified method defines the expected term as the average of the contractual term and the vesting period of the stock option. We estimate our expected volatility using a combination of our weighted-average implied volatility and our historical volatility. Prior to 2011, we estimated the volatility used as an input to the model based on an analysis of our stock price since our initial public offering in October 2006, as well as an analysis of similar public companies for which we have data. 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, 2011, we had not declared or paid any cash dividends, and we do not expect to pay any in the foreseeable future. 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. The assumptions used in calculating the fair value of stock-based payment awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. We will continue to use judgment in evaluating the expected term and volatility related to our own stock-based awards on a prospective basis, and incorporating these factors into the model. Changes in key assumptions will significantly impact the valuation of such instruments.
Intangible assets with finite useful lives, which include purchased technology, pharmacy and customer relationships, trade names, trademarks and website addresses, are amortized over their estimated useful lives and are reviewed for impairment when facts or circumstances suggest that the carrying value of these assets may not be recoverable.
We first assess qualitative factors to determine whether it is “more likely than not” that the fair value of our reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. We assess the impairment of goodwill annually. We assess the impairment of intangible assets when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Factors that we consider in deciding when to perform an impairment review include significant negative industry or economic trends or significant changes or planned changes in our use of the assets. We measure the recoverability of assets that will continue to be used in our operations by comparing the carrying value of the asset grouping to our estimate of the related total future undiscounted net cash flows. If an asset grouping’s carrying value is not recoverable through the related undiscounted cash flows, the asset grouping is considered to be impaired. The impairment is measured by comparing the difference between the asset grouping’s carrying value and its fair value. Fair value is the price that would be received from selling an asset in an orderly transaction between market participants at the measurement date. Goodwill and intangible assets are considered non-financial assets, and are recorded at fair value only when an impairment charge is recognized.
assets with finite useful lives. When we determine that the useful life of an asset is shorter than we had originally estimated, we accelerate the rate of amortization over the assets’ new, remaining useful life.
The following table sets forth our operating results and the related percentage of total revenues for the years ended December 31, 2009, 2010 and 2011 (dollars in thousands):
2010 compared to 2009-Commission revenue increased $16.1 million, or 14%, in 2010 compared to 2009, primarily due to an increase in our membership. Our estimated membership increased approximately 7% to 778,300 at December 31, 2010 from 728,000 at December 31, 2009. Commission revenue also increased as a result of a one-time commission payment of $6.0 million, which we received from one of our health insurance carrier partners on a number of existing policies, for which we had provided all services. Other revenue increased $9.4 million, or 60%, in 2010 compared to 2009, primarily due to an increase in Medicare lead referral revenue and, to a lesser extent, revenues related to a technology licensing contract with the federal government.
The following table presents our cost of revenue for the years ended December 31, 2009, 2010 and 2011 and the dollar and percentage change from the prior year (dollars in thousands):
2011 compared to 2010-Cost of revenue increased $2.8 million, or 52%, in 2011 compared to 2010, due primarily to an increase of $3.1 million in costs related to a technology licensing contract with the federal government, which began in the second half of 2010, and an increase of $0.7 million in amortization expense associated with the consideration paid in connection with several transactions in which we acquired broker of record status on a number of Medicare health insurance policies. These increases were partially offset by a decrease of $1.0 million in on-going revenue-sharing expense.
2010 compared to 2009-Cost of revenue increased $0.9 million, or 20%, in 2010 compared to 2009, due primarily to $1.9 million of costs we recognized related to a technology licensing contract with the federal government, partially offset by $0.6 million of amortization expense associated with the consideration paid in connection with a transaction in which we acquired broker of record status on a number of individual and family health insurance policies that were transferred to us and a decrease of $0.5 million in on-going revenue-sharing expense related to the transferred policies.
The following table presents our marketing and advertising expenses for the years ended December 31, 2009, 2010 and 2011 and the dollar and percentage change from the prior year (dollars in thousands):
The following table presents our customer care and enrollment expenses for the years ended December 31, 2009, 2010 and 2011 and dollar and percentage change from the prior year (dollars in thousands):
2011 compared to 2010-Customer care and enrollment expenses increased $5.1 million, or 29%, in 2011 compared to 2010, due primarily to a full year of incremental costs associated with our customer care center established in Salt Lake City, Utah in the second half of 2010, and to additional customer care center personnel hired in the second half of 2011 to service the increase in volume of Medicare leads serviced directly by us as a health insurance agent during the Medicare annual enrollment period in the fourth quarter of 2011. As a result, compensation, benefits and other personnel costs increased $4.1 million, insurance licensing costs increased $0.3 million and facility costs increased $0.4 million in 2011.
2011 compared to 2010-Technology and content expenses increased $2.4 million, or 13%, in 2011 compared to 2010, due primarily to an increase of $2.0 million in compensation, benefits and other personnel costs primarily as a result of the inclusion of a full year of technology and content costs associated with our acquisition of PlanPrescriber during the second quarter of 2010. Additionally, facility and operating costs increased $0.4 million as a result of increases in rent and co-location services.
2010 compared to 2009-Technology and content expenses increased $3.6 million, or 23%, for 2010 compared to 2009. This increase was primarily due to an increase of $2.4 million in compensation, benefits and other personnel costs primarily as a result of our acquisition of PlanPrescriber, an increase of $0.5 million in annual maintenance fees related to our hardware and software and an increase of $0.4 million in stock-based compensation expense due to additional equity grants to employees in our technology and content departments.
2010 compared to 2009-General and administrative expenses increased $4.0 million, or 20%, in 2010 compared to 2009, primarily due to a $1.5 million increase in professional fees associated with consulting services, a $1.1 million increase in stock-based compensation expense due to additional equity grants to general and administrative personnel and to members of our board of directors, a $0.8 million increase in compensation and benefits costs due to an increase in general and administrative personnel, primarily as a result of our acquisition of PlanPrescriber, and $0.6 million of acquisition-related costs related to our purchase of PlanPrescriber.
2011 compared to 2010 and 2010 compared to 2009-Interest income decreased in 2011 compared to 2010, and in 2010 compared to 2009, due primarily to a decline in the average yield earned on our invested cash and marketable securities. The decline in the average yield we earned on our investments was due primarily to a general market decline in interest rates and, in 2010, was also impacted by the mix of investments we held during 2010. During 2010, we reduced our investments in higher-yielding marketable securities. Administrative bank fees, investment management fees and interest expense on our capital lease obligations partially offset interest earned on our invested cash and marketable securities in 2010 and more than offset interest earned on our invested cash in 2011.
The following table presents our provision for income taxes for the year ended December 31, 2009, 2010 and 2011 and the dollar change from the prior year (dollars in thousands):
At December 31, 2011, our cash and cash equivalents totaled $123.6 million. Cash equivalents are comprised of financial instruments with an original maturity of 90 days or less from the date of purchase, primarily money market funds. At December 31, 2010, our cash and cash equivalents totaled $128.1 million.
The following table presents a summary of our cash flows for the years ended December 31, 2009, 2010 and 2011 (in thousands):
The cash flow statement for 2011 includes a $10.3 million cash flow benefit from deferred income taxes, of which approximately $5.6 million of tax benefit, primarily from the utilization of net operating loss carry forwards, is included in cash flow from operations and $4.7 million of net operating loss carry forwards, from the utilization of excess tax benefits related to share-based payments. The utilization of excess tax benefits related to share-based payments is also shown in the cash flow statements for 2011 as both a decrease in cash flow from operating activities and an increase in cash flow from financing activities.
2010-Our operating activities generated cash of $20.5 million during the year ended December 31, 2010 and consisted of net income of $17.5 million, increased by non-cash items of $11.2 million and partially offset by cash used for working capital and other activities of $8.2 million. Adjustments for non-cash items primarily consisted of $14.3 million of deferred income taxes, $6.4 million of stock-based compensation expense, $2.2 million of depreciation and amortization and $1.1 million of amortization of intangible assets, partially offset by $12.8 million of excess tax benefits from stock-based compensation. Cash used for working capital and other activities primarily consisted of an increase of $8.1 million in accounts receivable primarily due to the seasonality of our Medicare revenue, a decrease of $3.0 million in other current liabilities, an increase of $1.1 million in prepaid expenses and other current assets and a decrease of $0.5 million in accounts payable, partially offset by an increase of $2.4 million in deferred revenue and an increase of $2.3 million in accrued compensation and benefits.
2011-Net cash used in financing activities of $20.4 million during 2011 was due to $25.4 million used to repurchase 1.9 million shares of our common stock and $0.6 million used to net share settle equity awards, partially offset by $4.7 million of excess tax benefits from stock-based compensation and $0.9 million of proceeds received from the issuance of common stock pursuant to stock option exercises.
We lease certain of our office, operating facilities, equipment and furniture and fixtures under various operating leases, the latest of which expires in August 2018. 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, although actual cash payment obligations under certain of these agreements fluctuate over the terms of the agreements.
On July 8, 2011, we entered into an agreement to extend the lease on our headquarter office in Mountain View, California, for an additional seven years through August 2018. On September 8, 2011, we entered into an agreement to extend the lease on an adjacent office in Mountain View, California, for an additional two years through August 2013.
We have audited the accompanying consolidated balance sheets of eHealth, Inc. as of December 31, 2011 and 2010, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
Use of Estimates-The preparation of consolidated financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions that affect the amounts reported and disclosed in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates, including those related to, but not limited to, the useful lives of intangible assets, fair value of investments, fair value of intangible assets, estimates for commission forfeitures, valuation allowance for deferred income taxes, provision for income taxes, our assessment whether internal use software and website development costs will result in additional functionality and the assumptions used in determining stock-based compensation. We base our estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that we believe to be reasonable. Actual results may differ from these estimates.
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 income and comprehensive income. Depreciation and amortization is computed using the straight-line method based on estimated useful lives as follows:
Acquisition of PlanPrescriber-In April 2010, we acquired PlanPrescriber, Inc., formerly Experion Systems, Inc., a privately-held company. PlanPrescriber is a leading provider of online tools that help Medicare eligible individuals navigate their Medicare health insurance options. See Note 2-Acquisition of PlanPrescriber, Inc. for additional information.
Goodwill and Intangible Assets-Goodwill represents the excess of the consideration paid over the estimated fair value of assets acquired and liabilities assumed in a business acquisition. We do not amortize goodwill but test for impairment on an annual basis on or about November 30 of each year and whenever events or changes in circumstances indicate a reduction in its fair value below its carrying amount.
Intangible assets with finite useful lives, which include purchased technology, pharmacy and customer relationships, trade names, trademarks and website addresses, are amortized over their estimated useful lives and are reviewed for impairment annually on or about November 30 of each year or when facts or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
We must make subjective judgments in determining the independent cash flows that can be related to specific asset groupings. In addition, we must make subjective judgments regarding the remaining useful lives of assets with finite useful lives. When we determine that the useful life of an asset is shorter than we had originally estimated, we accelerate the rate of amortization over the assets’ new, remaining useful life. We evaluated the remaining useful lives of our intangible assets with finite lives in the fourth quarter of 2011 and determined no adjustments to the remaining lives were required.
Other Long-Lived Assets-We evaluate other long-lived assets for impairment 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 other long-lived assets were deemed impaired during the three-year period ended December 31, 2011.
Book of Business Transfers-In November 2010, May 2011 and October 2011, we entered into agreements with a partner, whereby the partner transferred certain of its existing Medicare plan members to us as the broker of record on the underlying policies in exchange for total consideration of $3.3 million, $3.1 million and $1.2 million, respectively, which is included in prepaid expenses and other current assets and other assets in the
Revenue Recognition-We recognize revenue for our services 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 plan, including individual, family, Medicare-related, small business, short-term and ancillary plans, for which we are entitled to receive compensation from an insurance carrier. We use the data supplied to us by insurance carriers to help identify the members for which we are receiving a commission payment and the amount received for each member, and to estimate future forfeiture amounts due to policy cancellations.
Commission Revenue-For individual, family, Medicare Supplement and small business plans, our compensation generally represents a percentage of the premium amount collected by the carrier during the period that a member maintains coverage under a policy (commissions) and, to a much lesser extent, override commissions that health insurance carriers pay us for achieving certain objectives. Premium-based commissions are reported to us after the premiums are collected by the carrier, generally on a monthly basis. 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. We recognize commission revenue for individual, family and small business plans as the commissions are reported to us by the carrier, net of an estimate for future forfeiture amounts due to policy cancellations. We determine that there is persuasive evidence of an arrangement when we have a commission agreement with a health insurance carrier, a carrier reports to us that it has approved an application submitted through our ecommerce platform and the applicant starts making payments on the policy. Our services are complete when a carrier has approved an application. The seller’s price is fixed or determinable and collectibility is reasonably assured when commission amounts have been reported to us by a carrier.
We recognize individual, family and small business commission override revenue when reported to us by a carrier based on the actual attainment of predetermined target sales levels or other objectives as determined by the carrier. Commission override revenue, which we recognize on the same basis as individual, family and small business commissions, is generally reported to us in a more irregular pattern than such commissions.
forfeiture amounts due to policy cancellations. For commissions paid to us on a monthly basis, we will record a receivable for the commission amounts to be received over the remainder of the policy year, net of an estimate for commission amounts not expected to be collected due to policy cancellations, which is included in accounts receivable in the accompanying balance sheets. We generally continue to receive the commission payments from the relevant insurance carrier until the earlier of our being notified that the health insurance policy has been cancelled, our no longer remaining the agent on the policy, or our commission term with the carrier expires, typically up to six years from the effective date of the policy. We determine that there is persuasive evidence of an arrangement when we have a commission agreement with a health insurance carrier. Our services are complete when a carrier has approved an application in the initial year and when a member has renewed in a renewal year. The seller’s price is fixed or determinable and collectibility is reasonably assured when a carrier has approved an application and the carrier reports to us the annual or first monthly renewal commission amount for each policy year.
Multiple-element Arrangements-In accordance with Accounting Standards Update (“ASU”) No. 2009-13-Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”), which was effective for us prospectively for revenue arrangements entered into or materially modified on or after January 1, 2011, we allocate revenue to all units of accounting within an arrangement with multiple deliverables at the inception of the arrangement using the relative selling price method. The relative selling price method allocates any discount in an arrangement proportionally to each deliverable on the basis of each deliverable’s relative selling price. The relative selling price established for each deliverable is based on vendor-specific objective evidence of fair value (“VSOE”) if available, third-party evidence of selling price if VSOE is not available, or best estimate of selling price if neither VSOE nor third-party evidence is available. When used, the best estimate of selling price reflects our best estimates of what the selling prices of certain deliverables would be if they were sold regularly on a stand-alone basis. Our process for determining best estimate of selling price for deliverables without VSOE or third-party evidence of selling price considers multiple factors that may vary depending upon the unique facts and circumstances related to each deliverable. Key factors considered by us in developing the relative selling prices for our technology licensing fees include prices charged by us for similar offerings and our historical pricing practices. We may also consider additional factors as appropriate, including competition. The adoption of ASU 2009-13 did not have a material impact to our results of operations or financial position.
Research and Development-Research and development expenses consist primarily of compensation and related expenses incurred for enhancements to the functionality of our website. Research and development costs, which totaled $5.2 million, $6.4 million and $7.3 million for the years ended December 31, 2009, 2010 and 2011, respectively, are included in technology and content expense in the accompanying consolidated statements of income and comprehensive income.
Internal-Use Software and Website Development Costs-We capitalize costs of materials, consultants and compensation and benefits costs of employees who devote time to the development of internal-use software; however, we usually expense as incurred website development costs for new features and functionalities because 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. Through December 31, 2011, the majority of our internal-use software and website development costs have been expensed as incurred.
401(k) Plan-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. In April 2006, we began matching employee contributions to our 401(k) Plan at 25% of an employee’s contribution each pay period, up to a maximum of 1% of the employee’s salary during such pay period. Our matching contributions are expensed as incurred and vest one-third for each of the first three years of the recipient’s service. The recipient is fully vested in all 401(k) Plan matching contributions after three years of service.
We utilize a two-step approach for evaluating uncertain tax positions. Step one, Recognition, requires a company to determine if the weight of available evidence indicates that a tax position is more likely than not to be sustained upon audit, including resolution of related appeals or litigation processes, if any. Step two, Measurement, is based on the largest amount of benefit, which is more likely than not to be realized on ultimate settlement.
We record interest and penalties related to uncertain tax positions as income tax expense in the consolidated financial statements.
Seasonality-The number of individual and family health insurance applications submitted through our ecommerce platform has generally increased in our first quarter compared to our fourth quarter and in our third quarter compared to our second quarter. Conversely, we have generally experienced a decline or flattening of individual and family submitted applications in our second quarter compared to our first quarter and in our fourth quarter compared to our third quarter. Since a significant portion of our marketing and advertising expenses are driven by the number of health insurance applications submitted on our ecommerce platform, those expenses are influenced by these patterns. The reasons for these seasonal patterns are not entirely clear.
The vast majority of Medicare plans are sold in the fourth quarter of each year during the Medicare annual enrollment period, when Medicare-eligible individuals are permitted to change their Medicare Advantage and Medicare Part D prescription drug coverage for the following year. As a result, we have generated the majority of our Medicare plan-related revenue in the fourth quarter of the year. We significantly increased our temporary customer care center staff during the third quarter in preparation for the Medicare annual enrollment period. We employ our temporary customer care center staff until the end of the Medicare annual enrollment period in December. As a result, our customer care center staffing costs are significantly higher in the third and fourth quarters compared to the first and second quarters. We also incurred significantly greater Medicare
plan-related online advertising expenses during the third and fourth quarters. Because the majority of our Medicare plan-related revenue is not generated until the fourth quarter, our temporary customer care center staffing costs and marketing expenses incurred in the third quarter have had a significant negative impact on our profitability during the third quarter.
Recent Accounting Pronouncements-In May 2011, the FASB issued updated accounting guidance related to fair value measurements and disclosures that result in common fair value measurements and disclosures between GAAP and International Financial Reporting Standards (“IFRS”). This guidance includes amendments that clarify the intent about the application of existing fair value measurements and disclosures, while other amendments change a principle or requirement for fair value measurements or disclosures. This guidance is effective for interim and annual periods beginning after December 15, 2011. The new guidance is to be adopted prospectively and early adoption is not permitted. We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.
Accounts Receivable-We do not require collateral or other security for our accounts receivable. As of December 31, 2011, one customer represented 73% of our $8.1 million outstanding accounts receivable. No other customers represented 10% or more of our total accounts receivable at December 31, 2011. We believe the potential for collection issues with any of our customers is minimal as of December 31, 2011. Accordingly, our estimate for uncollectible amounts at December 31, 2011 was not material.
As of December 31, 2010 and 2011, our accounts receivable consisted of the following (in thousands):
Concentration of Credit Risk-Our financial instruments that are exposed to concentrations of credit risk principally consist of cash, cash equivalents and accounts receivable. We invest our cash and cash equivalents
with major banks and financial institutions and, at times, such investments are in excess of federally insured limits. We also have deposits with major banks in China that are denominated in both U.S. dollars and Chinese Renminbi and are not insured by the U.S. federal government.
As a result of the streamlining of a legacy software product, we assessed intangible assets for impairment in the fourth quarter of 2011 and recorded an impairment charge of $0.3 million related to certain acquired intangible assets. The impairment charge is included in amortization of intangible assets on the consolidated statements of income and comprehensive income.
As of December 31, 2010 and 2011, our cash equivalents were invested in money market funds and were classified as Level 1. We endeavor to utilize the best available information in measuring fair value. We used observable prices in active markets in determining the classification of our money market funds as Level 1.
Preferred Stock-Our 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. As of December 31, 2010 and 2011, there were no shares of preferred stock outstanding.
Common Stock-On all matters submitted to our stockholders for vote, our common stockholders are entitled to one vote per share, voting together as a single class, and do not have cumulative voting rights. Accordingly, the holders of a majority of the shares of common stock entitled to vote in any election of directors can elect all of the directors standing for election, if they so choose. Subject to preferences that may apply to any shares of preferred stock outstanding, the holders of common stock are entitled to share equally in any dividends, when and if declared by our board of directors. Upon our liquidation, dissolution or winding-up, the holders of common stock are entitled to share equally in all assets remaining after the payment of any liabilities and the
liquidation preferences on any outstanding preferred stock. Holders of common stock have no preemptive or conversion rights or other subscription rights and there are no redemption or sinking funds provisions applicable to the common stock.
Shares Reserved-We issue common stock upon the exercise of stock options, the vesting of restricted stock units and upon granting of restricted common stock awards. Shares of authorized but unissued common stock reserved for future issuance were as follows (in thousands):
Our 2006 Equity Incentive Plan (the “2006 Plan”) became effective in October 2006. As of December 31, 2011, we had 3,870,346 shares of our common stock available for future grants under the 2006 Plan. In general, if options or shares awarded under the 2006 Plan are forfeited or repurchased, those options or shares will again become available for grant under the 2006 Plan. In addition, on January 1 of each year, the number of shares available for future grant under the 2006 Plan will automatically increase by the lowest of (a) 1,500,000 shares, (b) 4% of the total number of shares of our common stock then outstanding or (c) a lower number determined by our board of directors or its compensation committee. Employees, non-employee members of our board of directors and consultants of our company are eligible to participate in our 2006 Plan. The 2006 Plan requires that the exercise price of stock options and stock appreciation rights awarded shall in no event be less than 100% of the fair market value of a share of common stock on the date of grant.
The following table summarizes shares available for grant under our Stock Plans (in thousands):
(3) On January 1, 2009, 2010 and 2011, the number of shares authorized for issuance under the 2006 Plan was automatically increased pursuant to the terms of the 2006 Plan by 1,001,637 shares, 936,669 shares and 862,989 shares, respectively.
(4) Includes a grant of 115,080 restricted stock units with both service and performance-based vesting criteria to our executive officers.
(5) Includes 51,786 restricted stock units with both service and performance-based vesting criteria that were cancelled.
The following table summarizes option activity under the Stock Plans (in thousands, except per share amounts and weighted average remaining contractual life data):
The following table summarizes restricted stock unit activity under the Stock Plans (in thousands, except weighted average remaining contractual life data):
(1) The aggregate intrinsic value is calculated as eHealth’s closing stock price as of December 31 of each year presented in the table above multiplied by the number of restricted stock units outstanding on those dates.
(2) Includes a grant of 115,080 restricted stock units with both service and performance-based vesting criteria to our executive officers.
On July 27, 2010, we announced that our board of directors approved a stock repurchase program authorizing us to purchase up to $30 million of our common stock. In January 2011, we completed this stock repurchase program, having repurchased in the aggregate 2.3 million shares for approximately $30.0 million at an average price of $13.06 per share including commissions. Purchases under this repurchase program were made in the open market and complied with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. The cost of the repurchased shares was funded from available working capital.
The following table summarizes stock-based compensation expense recorded during the years ended December 31, 2009, 2010 and 2011 (in thousands):
The following table summarizes stock-based compensation expense by operating function included in the consolidated statements of income and comprehensive income for the years ended December 31, 2009, 2010 and 2011 (in thousands):
The following table provides a reconciliation of the federal statutory income tax rate to our effective tax rate for the years ended December 31, 2009, 2010 and 2011:
Our effective tax rates in 2010 and 2011 were higher than statutory federal and state tax rates primarily due to non-deductible lobbying expenses, tax shortfalls related to share-based payments, non-deductible acquisition-related costs incurred as a result of the purchase of PlanPrescriber and additional state tax expense resulting from an increase in valuation allowance against state deferred tax assets resulting from a reduction in California apportionment. Our effective tax rate in 2009 was higher than statutory federal and state tax rates primarily due to non-deductible lobbying expenses and tax shortfalls related to share-based payments, partially offset by an income tax adjustment related to an increase in our deferred income tax assets resulting from a reduction in estimated limitations on both our federal and California net operating loss carry forwards.
For tax return purposes, we had net operating loss carry forwards at December 31, 2011 of approximately $7.8 million and $72.9 million for federal income tax and state income tax purposes, respectively. Included in the state net operating loss carry forward are unrealized state net operating loss deductions resulting from stock option exercises of approximately $55.4 million. The benefit of these unrealized stock option-related deductions has not been included in the deferred tax assets table above and will be recognized as a credit to additional paid-in capital when realized. Federal and state net operating loss carry forwards begin expiring in 2021 and 2012, respectively. The federal net operating loss carry forward is subject to an annual limitation of approximately $2.5 million due to section 382 of the Internal Revenue Code. Approximately $2.9 million of the state net operating loss carry forward is subject to an annual limitation of approximately $0.2 million due to section 382 of the Internal Revenue Code.
As of December 31, 2010 and 2011, there were $2.6 million and $3.5 million, respectively, of unrecognized tax benefits, that, if recognized, would impact the effective tax rate.
Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period (excluding shares subject to repurchase). Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common and common
Total rent expense under all operating leases was approximately $3.4 million, $3.5 million and $4.0 million for the years ended December 31, 2009, 2010 and 2011, respectively. Future minimum lease payments under non-cancellable operating leases and certain contractual service and licensing obligations at December 31, 2011 were as follows (in thousands):
Leases-We lease certain of our office, operating facilities, equipment and furniture and fixtures under various operating leases, the latest of which expires in August 2018. 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, although actual cash payment obligations under certain of these agreements fluctuate over the terms of the agreements.
Significant Customers-Substantially all revenue for all years presented was generated from customers located in the United States. Carriers representing 10% or more of our total revenue in any of the years ended December 31, 2009, 2010 and 2011 are presented in the table below:
Commission revenue attributable to major medical individual and family health insurance plans was approximately 91%, 91% and 86% of our commission revenue in the years ended December 31, 2009, 2010 and 2011, respectively. We define our individual and family plan offerings as major medical individual and family health insurance plans, which do not include small business, short-term major medical, stand-alone dental, life, student and Medicare-related health insurance plan offerings.
As of December 31, 2011, one customer represented 73% of our $8.1 million outstanding accounts receivable. No other customers represented 10% or more of our total accounts receivable at December 31, 2011.
Revenue for the three months ended December 31, 2010 included a one-time commission payment of $6.0 million, which we received from one of our health insurance carrier partners on a number of existing policies, for which we had provided all services.