You should read the following selected consolidated financial data in conjunction with Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and our consolidated financial statements and the related notes included in Part IV, Item 15, "Exhibits and Financial Statement Schedules" of this Annual Report on Form 10-K.
The consolidated statements of income data for each of the years ended December 31, 2018, 2017, and 2016 and the consolidated balance sheets data as of December 31, 2018 and 2017 are derived from our audited consolidated financial statements included in Part IV, Item 15, "Exhibits and Financial Statement Schedules" of this Annual Report on Form 10-K. Further, see Notes 1 and 9 of Part IV, Item 15, for a discussion on our adoption of ASC 606 and its impact on our consolidated statements of income and consolidated balance sheets. The consolidated statements of income data for the years ended December 31, 2015, and 2014, and the consolidated balance sheets data as of December 31, 2016, 2015, and 2014 are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of our results in any future period.
Amounts reported in 2018 reflect the adoption of ASC 606 as further detailed in Notes 1 and 9 of Part IV, Item 15, of this Annual Report on Form 10-K.
We have identified our customers as insurance carriers and non-insurance plan providers. We have identified two performance obligations to our customers for the IFP and HBIP that we sell, which include sales and marketing services, and member management. We have allocated the transaction price to each performance obligation in an amount that depicts the amount of consideration to which we expect to be entitled in exchange for satisfying each performance obligation. Our sales and marketing performance obligations for IFP, non-insurance, and supplemental products are complete once the consumer meets the standards established by our customer for enrollment. Revenue for that performance obligation is equal to approximately 95% of the estimated total collections for our services, at the time of enrollment. In addition, we recognize approximately 5% of the estimated monthly collections, for member management, for each month that the member continues to renew their policy. The estimated revenue we expect to collect upon enrollment will vary based on product type and the estimated life of the respective insurance or non-insurance product. These estimates may vary with our actual experience however revenue is constrained such that is it probable that no significant reversals in revenue should occur.
We expect that the adoption of the new standard will highlight the seasonality of our revenues. We expect to recognize greater revenue in the fourth quarter of each year as a result of the increase in submitted policies we generally experience during the fourth quarter due to the Patient Protection and Affordable Care Act open enrollment periods.
Our key metrics and financial results for 2018 are as follows:
Policies in force as of December 31, 2018, totaled 387,000, compared to 376,100 as of December 31, 2017, an increase of 2.9%.
Revenue under ASC 606 was $351.1 million, compared to revenue under ASC 605 of $250.5 million in 2017, an increase of 40.2%.
Adjusted EBITDA was $59.4 million, compared to $45.9 million in 2017, an increase of 29.4%.
Adjusted earnings per share, also referred to as adjusted net income per share, or adjusted EPS, was $2.60 compared to $1.67 in 2017, an increase of 55.7%.
In addition to traditional financial metrics, we rely upon the following key business metrics to evaluate our business performance and facilitate long-term strategic planning:
Premium Equivalents. We define this metric as our total collections, including the combination of premiums, fees for discount benefit plans, enrollment fees, and third-party commissions and referral fees. All amounts not paid out as risk premium to carriers or paid out to other third-party obligors are considered to be revenues for financial reporting purposes. We have included premium equivalents in this report because, while diminishing in importance since the adoption of ASC 606, it has historically been a key measure used by our management to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget and to develop short- and long-term operational plans. In particular, the inclusion of premium equivalents can provide a useful measure for period-to-period comparisons of our business. This financial measurement is considered a non-GAAP financial measure and is not recognized under generally accepted accounting principles in the United States of America (“GAAP”) and should not be used as, and is not an alternative to, revenues as a measure of our operating performance.
Revenues. Our revenues primarily consist of commissions and fees earned for health insurance policies and supplemental products issued to members, referral fees, and fees for discount benefit plans paid by members as a direct result of our enrollment services, brokerage services, or referral sales. Revenues reported by the Company are net of risk premiums remitted to insurance carriers and fees paid for discount benefit plans.
Commission rates that we receive for the sale of products are agreed to in advance with the relevant insurance carrier and vary by carrier and policy type. Under our carrier compensation arrangements, the commission rate schedule that is in effect on the policy effective date governs the commissions over the life of the policy. All amounts due to insurance carriers and discount benefit vendors are reported and paid to them according to the procedures provided for in the contractual agreements between the individual carrier or vendor and us.
We continue to receive a commission payment for each month a member renews their policy, or until the plan expires or is terminated.
Policies in Force. We consider a policy to be in force when we have issued a member his or her insurance policy or discount benefit plan and have collected the applicable premium payments, commissions, and/or discount benefit fees. Our policies in force are an important indicator of our expected revenues. A member may be enrolled in more than one policy or discount benefit plan simultaneously. A plan becomes inactive upon notification to us of termination of the policy or discount benefit plan, when the member’s policy or discount benefit plan expires or following non-payment of premiums or discount benefit fees when due.
EBITDA. We define this metric as net income before interest, income taxes and depreciation and amortization. We have included EBITDA in this report because it is a key measure used by our management and board of directors to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget and to develop short- and long-term operational plans. In particular, the exclusion of certain expenses in calculating EBITDA can provide a useful measure for period-to-period comparisons of our business. However, EBITDA does not represent, and should not be considered as, an alternative to net income or cash flows from operations, each as determined in accordance with GAAP. Other companies may calculate EBITDA differently than we do. EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP.
During the three months ended June 30, 2018, the Company began including in adjusted EBITDA, the payments related to employer taxes for vesting and exercises of stock-based compensation. For period-over-period comparability, the Company has included these amounts in the year ended 2017, and 2016, previously reported numbers. For the year ended 2017, the impact on adjusted EBITDA was an approximate increase of $486,000. For the year ended 2016, the impact on adjusted EBITDA was an approximate increase of $26,000. This resulted in a $0.02 increase in adjusted net income for the year ended 2017 and no change to adjusted net income for the year ended 2016.
Adjusted Net Income. To calculate adjusted net income, we calculate net income then add back amortization (but not depreciation), interest, tax expense, items such as stock-based compensation and related costs, and other items that are not generally a part of regular operating activities, including, tax receivable adjustments, indemnity and other related legal costs, severance, restructuring, and acquisition costs. From adjusted pre-tax net income we apply a pro forma tax expense calculated at an assumed rate of 24%, which consists of the maximum federal corporate rate of 21%, with an assumed 3% state tax rate. Prior to the implementation of H.R.1, commonly known as the Tax Cuts and Jobs Act, signed into law on December 22, 2017, we applied an assumed pro forma tax rate of 38%. We believe that when measuring Company and executive performance against the adjusted net income measure, applying a pro forma tax rate better reflects the performance of the Company without regard to the Company’s organizational tax structure. We have included adjusted net income in this report because it is a key performance measure used by our management to understand and evaluate our core operating performance and trends and because we believe it is frequently used by analysts, investors, and other interested parties in their evaluation of the Company. Other companies may calculate this measure differently than we do. Adjusted net income has limitations as an analytical tool, and you should not consider it in isolation or substitution for earnings per share as reported under GAAP.
Adjusted Net Income per Share. Adjusted net income per share is computed by dividing adjusted net income by the total number of weighted-average diluted Class A and weighted-average Class B shares of our common stock for each period. We have included adjusted net income per share in this report because it is a key measure used by our management to understand and evaluate our core operating performance and trends and because we believe it is frequently used by analysts, investors and other interested parties in the evaluation of companies. Other companies may calculate this measure differently than we do. Adjusted net income per share has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for earnings per share as reported under GAAP.
The following table presents a reconciliation of SG&A to Adjusted SG&A ($ in thousands):
Revenues for the year ended December 31, 2018 were $351.1 million, an increase of $100.6 million, compared to 2017, which continues to be reported under ASC 605. Drivers of the increase in revenue were attributable to the point-in-time recognition of 95% of the estimated lifetime value of policies as well as favorable commission margins and improved HBIP offerings. Increases in revenue attributable to ASC 606 were approximately $60.0 million.
Revenues for the year ended December 31, 2017 were $250.5 million, an increase of $66.0 million, or 35.7%, compared to 2016. The increases were primarily due to a 29.6% year over year growth, in the number of policies in force, to 376,100 at December 31, 2017 from 290,100 at December 31, 2016. The increase in revenues was driven by an increase in policies in force, favorable commission margins, and improved discount benefit plan offerings.
Our third-party commissions consist of fees and commissions paid to third-party distributors for selling our products to members. Third-party commissions, as a percentage of revenue, will vary based on the mix of sales between AgileHealthInsurance.com and our third-party distributors.
Third-party commissions represented 58.0% of revenues for the year ended December 31, 2017, as compared to 58.4% and of revenues for 2016. These changes were largely the result of changes in product mix.
Our SG&A expenses primarily consist of personnel costs, which include salaries, bonuses, commissions, stock-based compensation, payroll taxes and benefits. SG&A expenses also include selling and marketing expenses and travel costs associated with obtaining new distributor relationships. In addition, these expenses also include expenses for outside professional services and technology expenses, including legal, audit and financial services, and the maintenance of our administrative technology platform and marketing costs for online advertising.
The increase in SG&A expenses for the year ended December 31, 2018 compared to the same period 2017 was primarily attributable to an approximate $5.0 million increase in stock-based compensation, $3.4 million in accrued expenses related to the closing of the market conduct examination, and a $3.4 million increase in severance, restructuring and other charges related to severance payments for our founder and other executives.
SG&A expense for the year ended December 31, 2017 was $64.4 million. This represents an increase of $12.9 million, or 25.1%, for the year ended December 31, 2017 compared to 2016.
SG&A expense represented 25.7% of revenues for the year ended December 31, 2017 compared to 27.9% of revenues for 2016.
For the year ended December 31, 2018, there was $1.5 million of expense recorded under the Tax Receivable Agreement ("TRA"). TRA income for the year ended December 31, 2017 was $11.8 million, primarily due to changes in the Tax Act. See Note 11 for further information on the Tax Act.
For the year ended December 31, 2017, there was $11.8 million of income recorded under the TRA as a result of recent changes in the Tax Act. Conversely, TRA expense for the year ended December 31, 2016 was $9.7 million, primarily due to our revised estimate of the probability of such future payments. See Note 13 of the accompanying consolidated financial statements for further information on the TRA with the holders of HPIH Series B Membership Interests.
For 2018, we recorded a provision for income tax expense of $10.7 million, reflecting an effective tax rate of 36.0%. For 2017, we recorded a provision for income tax expense of $16.8 million, reflecting an effective tax rate of 38.8%. We completed our analysis of the impacts of U.S. tax reform in the fourth quarter of 2018 and recognized approximately $250,000 reduction to the provisional tax amounts recorded in the fourth quarter of 2017, which is included as a component of income tax expense from continuing operations.
For 2017, we recorded a provision for income tax expense of $16.8 million, reflecting an effective tax rate of 38.8%. On December 22, 2017, the Tax Cuts and Jobs Act was enacted. U.S. tax reform, among other things, reduced the U.S. federal income tax rate from 35% to 21% for 2018 which led to the recognition a provisional income tax charge of $12.6 million in the fourth quarter of 2017 due to the re-measurement of our deferred tax assets, which was included as a component of the income tax provision on our consolidated statement of income.
We are the sole managing member of HPIH and have 100% of the voting rights and control. As of December 31, 2018, we had an 83.0% economic interest in HPIH, whereas HPI and HPIS collectively held the remaining 17.0%. As of December 31, 2017, we had a 76.3% economic interest in HPIH, whereas HPI and HPIS collectively held the remaining 23.7%. HPI and HPIS’s interest in HPIH is reflected as a noncontrolling interest on our accompanying consolidated financial statements contained elsewhere in this report. The decrease in economic interest for HPI and HPIS in 2018 was due to do the exchange of 1,300,000 Class B shares for Class A on June 7, 2018.
As of December 31, 2017, we had a 76.3% economic interest in HPIH, whereas HPI and HPIS collectively held the remaining 23.7%. As of December 31, 2016, we had a 54.0% economic interest in HPIH, whereas HPI and HPIS collectively held the remaining 46.0%. The decrease in economic interest for HPI and HPIS in 2017 was due to do the exchange of 3,000,000 Class B shares for Class A on March 8, 2017. See Note 8 of the accompanying audited financial statements for further information on the exchange agreement.
The following tables set forth our unaudited quarterly consolidated statements of income data for each of the eight quarters in the period ended December 31, 2018. We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included in Part IV, Item 15, "Exhibits and Financial Statement Schedules" in this Annual Report on Form 10-K. Quarterly amounts reported for the year ended December 31, 2018 have been adjusted to reflect the impact of adopting ASC 606 at December 31, 2018 under the modified retrospective application, applied to the opening balance sheet as of January 1, 2018. For detailed disclosures surrounding the impact of the adoption of ASC 606 and its impact on the opening balance sheet, see Notes 1 and 9 included in Part IV, Item 15 in this Annual Report on Form 10-K.
In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, and the adoption of ASC 606, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in Part IV, Item 15, "Exhibits and Financial Statement Schedules" in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period. All tables below (in thousands, except per share data):
The Company filed a registration statement on Form S-3 to offer and sell, from time to time, up to $150.0 million of any combination of debt securities, Class A Common Stock, preferred stock, warrants, subscription rights, units, or purchase contracts as described in the related prospectus. At December 31, 2018 the Company had not sold any securities under this Registration Statement. See Note 8 to the consolidated financial statements for additional details on our registration statement.
The following table presents a summary of cash flows ($ in thousands):
Net cash provided by operating activities during the fiscal year ended December 31, 2018 decreased compared to 2017 primarily due to changes in net income before noncontrolling interests and increases in advanced commission payments to our independent third-party distributors. Changes in operating assets and liabilities were largely driven by the adoption of ASC 606. ASC 606 created a net contract asset that relates to the acceleration of revenue for performance obligations recognized at a point-in-time. Due to ASC 606, a significant increase in commissions payable was recognized because the future lifetime expected commissions to be paid to third-party distributors are now recognized at a point-in-time. Lastly, significant impacts in income taxes and deferred income taxes were driven by ASC 606.
Net cash used in investing activities during the fiscal year ended December 31, 2018 decreased compared to 2017 and was primarily the result of a relative decrease in amounts spent on capitalized internal-use software.
Net cash used in financing activities during the fiscal year ended December 31, 2018, increased significantly over 2017 primarily due to an approximate $51.0 million increase in Class A common stock share repurchases under our share repurchase plan. These cash outflows were offset by draws on our revolving credit facility of $15.0 million in 2018. See Note 7 and 8 for further information on our credit facility and our share repurchase program, respectively.
Our significant accounting policies are outlined in Note 1 to the consolidated financial statements included in this Form 10-K. Our financial statements are prepared in accordance with GAAP. The preparation of these financial statements requires our management to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the applicable periods. We base our estimates, assumptions and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances. Different assumptions and judgments could change the estimates used in the preparation of our financial statements, which, in turn, could change the results from those reported. We evaluate our estimates, assumptions and judgments on an ongoing basis. The critical accounting estimates, assumptions and judgments that we believe have the most significant impact on our financial statements are described below.
Our primary revenue sources are from the sale of IFP and supplemental products. Our contracts with customers often include promises to transfer multiple services to a customer. In determining how revenue should be recognized, a five-step process is used, which requires management judgment and estimates within the revenue recognition process. These judgments and estimates include (i) determining the standalone sales price ("SSP") for each distinct performance obligation; and (5) estimating the amount of variable consideration to include in the transaction price.
With the adoption of ASC 606, the Company applied guidance under ASC 340 and was required to record the estimated lifetime commissions expected to be paid to distributors. Duration estimates used in revenue recognition have a significant impact on the amount of commissions expense we recognize, and the related liability recorded for the estimated lifetime commission payments not yet made. The duration estimates applied to revenue are applied to the associated commissions.
We accounted for the tax effects of the Tax Cuts and Jobs Act (“Tax Act”), enacted on December 22, 2017, on a provisional basis in our 2017 consolidated financial statements. We completed our accounting in the fourth quarter of 2018, within the one year measurement period from the enactment date.
Note 1 to the consolidated financial statements contains a summary of the Company’s significant accounting policies, including a discussion of recently issued accounting pronouncements and their impact or potential future impact on the Company’s financial results, if determinable, under the sub-heading “Recent Accounting Pronouncements.”
For the year ended December 31, 2018, two carriers accounted for 64% of our total collections compared to three carriers who accounted for 54% of our total collections at December 31, 2017. The Company anticipates that total collections in 2019 will continue to be concentrated among a small number of carriers, although as a part of the Company’s strategy of improving and increasing its product mix by seeking to add innovative new products, the Company anticipates that its carrier concentration may decrease. See Note 17 "Concentrations of Credit Risk and Significant Customers" of the accompanying consolidated financial statements for further information.