As of December 31, 2013, we leased 9,700 square feet of space for our headquarters in Tampa, Florida under a lease that expires in 2017. In addition, as of December 31, 2013, we leased approximately 15,536 square feet of space for Secured in Sunrise, Florida under a lease that expires in 2016, and we subleased approximately 4,000 square feet of space for our ICE in Boca Raton, Florida under a lease that expires in 2015. We believe that suitable additional or alternative space will be available in the future on commercially reasonable terms to accommodate our foreseeable future expansion.
We are an industry leader in the sale of up to six, 11 and approximately 12-month (i.e., up to 364 day) STM plans, an alternative to PPACA-qualified IMM plans, which provide lifetime renewable coverage. STM plans generally offer qualifying individuals comparable benefits for fixed short-term durations of six, 11 or 12 months generally at lower premiums than IMM plans. STM plans feature a streamlined underwriting process offering immediate coverage options. We also offer guaranteed-issue hospital indemnity plans for individuals under the age of 65, which pay fixed cash benefits for covered procedures and services, and a variety of ancillary products such as pharmacy benefit cards, dental plans, vision plans and cancer/critical illness plans that are frequently purchased as supplements to STM and hospital indemnity plans. We design and structure insurance products on behalf of insurance carriers, market them to individuals through our internal distribution capacity, which was expanded through the July 2013 acquisition of Secured, formerly one of our independent distributors, and through our large network of distributors and manage member relations via our online member portal, which is available 24 hours a day, seven days a week. Our online enrollment process allows us to aggregate and analyze consumer data and purchasing habits to track market trends and drive product innovation. We have established relationships
We focus on the large and under-penetrated segment of the U.S. population who are uninsured or underinsured, which includes individuals not covered by employer-sponsored insurance plans, such as the self-employed as well as small business owners and their employees, individuals who are unable to afford IMM premiums, and underserved “gap populations” that require insurance due to changes caused by life events: new graduates, divorcees, early retirees, military discharges, the unemployed, part-time and seasonal employees and temporary workers and customers seeking health insurance between the open enrollment periods held each year by the Exchanges. According to U.S. Census Bureau estimates, approximately 48 million Americans were uninsured in 2012.
As of December 31, 2013, we had 28,709 STM plans in force, compared with 23,747 on December 31, 2012. We earn our revenues from commissions and fees related to the sale of products to our members. Our ancillary products have created several additional revenue streams and resulted in a significant portion of our business being generated by monthly member renewals. For the year ended December 31, 2013, our premium equivalents and revenues were $100.0 million and $56.6 million, respectively, representing increases of 31.8% and 35.0%, compared to the year ended December 31, 2012. For more detail about the use of premium equivalents as a business metric and a reconciliation of premium equivalents to revenues, see “Key Business Metrics-Premium Equivalents” below.
Effects of the IPO and Related Transactions on our Corporate Structure
Historically, our business was operated through HPI. In anticipation of the IPO, on November 7, 2012, HPI assigned the operating assets of our business through a series of transactions to HPIH, and HPIH assumed the operating liabilities of HPI. Since November 2012, all of our business is conducted through HPIH.
Premium equivalents. We define this metric as the combination of premiums, fees for discount benefit plans, and enrollment 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 it is 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.
Plans in force. We consider a plan 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 and/or discount benefit fees. Our plans in force are an important indicator of our expected revenues, as we receive a monthly commission for up to six months for our six-month STM plans, up to 11 months for our 11 months plans, up to 12 months for our approximately 12-month (i.e., up to 364 days) STM plans and often more than 12 months for our hospital indemnity and discount benefit plans, provided that the policy or discount benefit plan is not cancelled. 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.
The following table presents a reconciliation of premium equivalents and revenues to non GAAP gross margin ($ in thousands):
The following table presents a reconciliation of net income to EBITDA and adjusted EBITDA for the years ended December 31, 2013 and 2012 ($ in thousands):
Net loss for the year ended December 31, 2013 includes a one-time expense of $5.5 million related to the termination of contact rights with TSG Agency, LLC (“TSG”), a managing general agent of the Company. For further information, see “Comparison of 2013 and 2012” below.
Our revenues consist primarily of commissions earned for our insurance policies and discount benefit plans issued to members, enrollment fees paid by members and administration fees paid by members as a direct result of our enrollment services. We recognize revenues upon the member’s acceptance of a policy. Commissions and fees attributable to the sale of STM plans, hospital indemnity policies and ancillary products represented substantially all of our revenues for the periods presented. Our revenues represent premiums and fees for discount benefit plans, net of risk premium and amounts earned by third-party obligors, respectively. We recognize commissions as we collect the premiums and fees for discount benefit plans.
Commission rates for all insurance plans are approved in advance by the relevant insurance carrier. Our commission rates and the length of the commission period typically vary by carrier and plan type. Under our carrier compensation arrangements, the commission rate schedule that is in effect on the policy effective date will govern the commissions over the life of the plan.
Our third-party commissions consist of fees and commissions paid to distributors for selling our products to members, which we pay monthly for existing members and on a weekly basis for new members. As noted above, in July 2013, we acquired Secured, a significant distributor, and third-party commissions decreased as a percentage of revenues during the remainder of 2013. Third-party commissions in 2013 were also reduced by the termination of our contract with TSG, a managing general agent.
Our credit card and ACH fees are fees paid to our banks and processors for the collection of credit card and ACH payments. We expect credit card and ACH fees as a percentage of revenue in future periods to remain generally consistent with prior periods.
Interest expense primarily consists of interest incurred on our outstanding bank note that was repaid in February 2013 with a portion of the net proceeds raised from the IPO and interest expense on a long-term noncompete agreement. Interest expense is partially offset by interest income earned on cash equivalents and investments.
Other expense (income) includes expenses payable to Mr. Kosloske pursuant to the tax receivable agreement as described above and fees charged to distributors for advanced commissions, whereby we pay distributors commissions on policies sold in advance of
when they would ordinarily be due to the distributor. These advanced commissions are made to distributors with an established track record of selling our products. Advanced commission fees range from 0% up to 2% of the premiums for each month that we advance commissions. Advanced commissions to a distributor are based upon the number of future months of expected premium equivalent multiplied by a distributor’s commission rate. We expect other income to increase as we expand our advanced commission structure.
Our former operating entity, HPI, is taxed as an S corporation for income tax purposes. Therefore, we were not subject to entity-level federal or state income taxation prior to the IPO. HPIH is currently taxed as a partnership for federal income tax purposes; and as a result, the members pay taxes with respect to their allocable shares of HPIH’s respective net taxable income.
On June 1, 2012, we and TSG acquired ICE. ICE conducts call center operations and is a training facility for our distributors. Pursuant to the terms of the transaction, we contributed $80,000 in cash, and TSG contributed $20,000 in cash to the newly created limited liability company. In connection with the transaction, we received an 80% controlling interest in ICE and TSG received a 20% noncontrolling interest in ICE. The intent of this transaction was to attract potential call center managers and educate them on our model and best practices with the ultimate goal of these call centers joining our distribution network. During the year ended December 31, 2013, we contributed $40,000, and TSG contributed $16,000 to ICE. On June 30, 2013, we acquired TSG’s interest in ICE for $90,000, and ICE became a wholly-owned subsidiary.
Revenues for 2013 were $56.6 million, an increase of $14.7 million, or 35.0%, compared to 2012. The increase was primarily due to a 26.8% increase in the number of policies in force. The number of hospital indemnity and ancillary policies in force as of December 31, 2013 and 2012 increased as we increased our focus on the sales of our other products to complement our STM sales.
Third-party commissions represented 56.9% of revenues for 2013 as compared to 66.4% of revenues for 2012. This decrease was primarily due to the acquisition of Secured and the elimination of override commission payments previously paid to TSG. We terminated certain contract rights with TSG in March 2013. See “Contract Termination Expense” below.
Selling, general and administrative expenses for 2013 were $24.0 million, an increase of $15.3 million compared to 2012. The increase in selling, general and administrative expenses was attributable to stock based compensation under our long term incentive plan, the expansion of our workforce, our acquisition of Secured and our status as a publicly-traded company. We expect higher selling, general and administrative expenses in future periods as we have added executives to implement various growth strategies. Increases associated with our business growth initiatives, including our enhanced marketing and lead generation plans, are expected. In addition, expense for equity-based compensation to existing employees is expected to be lower in 2014 than in 2013.
We incurred $6.3 million in stock-based compensation expense for 2013 from grants to directors, officers and employees under our long-term incentive plan. Additional personnel costs increased $1.9 million as the result of an increase in our payroll in connection with our business expansion. In addition, director and officer insurance expense increased by $479,000, as compared to 2012.We also incurred $163,000 in director compensation as well as other administrative expenses associated with operating ICE of approximately $962,000.
Interest expense for 2013 was $1,000, a decrease of $270,000 compared to 2012. Interest expense decreased primarily due to the bank loan agreement that we repaid in full subsequent to the closing of our IPO and was partially offset by interest income on cash equivalents and short-term investments.
As of December 31, 2013, we had $17.1 million of cash and cash equivalents and $6.9 million of short-term investments. Our balance of cash and cash equivalents and short-term investments increased primarily as a result of the IPO.
We believe that our available cash and cash flows expected to be generated from operations will be adequate to satisfy our current and planned operations for at least the next 12 months.
In 2013, HPIH paid $2.2 million in distributions to entities beneficially owned by Mr. Kosloske, excluding $916,000 that were payable as of December 31, 2013. These distributions were required under the amended and restated limited liability company agreement of HPIH and reflect estimates of tax liability.
As of December 31, 2012, the outstanding balance of the term loan was $3.3 million.
The following summary of cash flows for the periods indicated has been summarized from our financial statements included elsewhere in this report ($ in thousands):
We experienced negative cash flows from operating activities during 2013 and positive cash flow from operating activities during 2012. The cash used in operating activities for 2013 was primarily attributable to the $5.5 million contract termination expense described above, increases in advanced commissions and increased selling, general and administrative expenses, partially offset by an in increase in revenues.
In 2013 cash provided by financing activities was $50.1 million as compared to cash used in financing activities of $5.0 million for 2012. Cash provided by financing activities in 2013 consisted of $60.8 million in net proceeds from the IPO, partially offset by payments made on debt and other obligations of $7.2 million, payments of equity issuance costs of $1.6 million and $2.2 million of distributions to members of HPIH. Cash used in financing activities for 2012 consisted of payments on debt and other obligations in the amount of $905,000, payments of equity issuance costs of $1.0 million and $3.2 million in distributions made to members, which were offset by proceeds from notes payable of $100,000 and contributions from TSG to ICE of $92,000.
Through December 31, 2013, we had not entered into any off-balance sheet arrangements, other than the operating leases noted above under which we had aggregate future minimum lease payments of $1.0 million as of December 31, 2013, as further described in Note 13 of the accompanying consolidated financial statements.
HPI and its subsidiary, which are beneficially owned by Mr. Kosloske, are related parties by virtue of their Series B Membership interests in HPIH, of which we are managing member. During the year ended December 31, 2013, HPIH paid cash distributions of $2.2 million to these entities related to estimated federal and state income taxes, pursuant to the limited liability company agreement entered into by HPIH and HPI, including $944,000 which was paid prior to the IPO. As of December 31, 2013, an accrued distribution of $916,000 was recorded related to remaining distributions of estimated federal income taxes due to HPI and its subsidiary and is included in due to member on the accompanying consolidated balance sheets. See “Item 1. Business-Our History and the Reorganization of Our Corporate Structure-Amended and Restated Limited Liability Company Agreement of HPIH” for a further description of the limited liability company agreement.
On February 13, 2013, we entered into a tax receivable agreement with HPI and its subsidiary. See “Item 1. Business-Tax Receivable Agreement” for further description of the tax receivable agreement.
In August 2012, we entered into a promissory note with Ivan Spinner, who controls TSG, in the amount of $100,000 for the purpose of funding advanced commissions. The note was non-interest bearing and required equal monthly payments of $25,000 beginning September 20, 2012 and ending December 20, 2012. This loan was modified on October 18, 2012 whereby the November and December payments were deferred to January 2, 2013 and February 1, 2013, respectively. The note had a balance of $50,000 at December 31, 2012 and was repaid during the first quarter of 2013.
On June 30, 2013, we purchased TSG’s interest in ICE for a cash payment to TSG of $90,000.
In October 2013, HPIH formed SIL with HBO, one of our distributors. HBO is a related party by virtue of its 50% ownership of membership interests in SIL. During 2013, we made net advanced commissions payments of $801,000, and recognized $906,000 of commission expense related to HBO. As of December 31, 2013, the advanced commissions balance related to HBO included in the accompanying consolidated balance sheets was $457,000.
Our revenues consist of commissions earned for health insurance policies and discount benefit plans issued to members, enrollment fees paid by members, and administration fees paid by members as a direct result of our enrollment services. The members’ payments includes a combination of risk premium, fees for discount benefit plans, fees for distributors and an enrollment fee, which are collectively referred to as “Premium equivalents.” Revenues reported by the Company are net of premiums remitted to insurance carriers and fees paid for discount benefit plans. Revenues are net of an allowance for policies expected to be cancelled by members during a limited cancellation period. We establish an allowance for estimated policy cancellations through a charge to revenues. The allowance is estimated using historical data to project future experience. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported. We periodically review the adequacy of the allowance, which generally has been accurate in the past, and record adjustments as necessary. Historically, the variation of those estimates to actual results is immaterial and material variation is not expected in the future. The net allowance for estimated policy cancellations as of December 31, 2013 and 2012 were $191,000 and $77,000.
Under FASB guidance, the process of evaluating the potential impairment of goodwill involves a two-step process and requires significant judgment at many points during the analysis. In the first step, we determine whether there is an indication of impairment by considering relevant quantitative factors or comparing the fair value of the reporting unit to its carrying amount, including goodwill. Our annual impairment test is performed with a measurement date of October 1. If, based on the first step, we determine that there is a quantitative indication of goodwill impairment, we assess the impairment in step two in accordance with FASB guidance.
After computing a separate business enterprise value under the above approaches, we apply a weighting to them to derive the business enterprise value of the reporting unit. The weightings are evaluated each time a goodwill impairment assessment is performed and give consideration to the relative reliability of each approach at that time. Based on these weightings, we calculated a business enterprise value for the reporting unit. The implied fair value is then compared to the reporting unit’s carrying value. Upon completion of the analysis in step one as of October 1, 2013, we determined that the fair value of the business exceeded its respective carrying value. As such, a step two analysis was not required.
The resulting compensation expense is recognized over the requisite service period. The requisite service period is the period during which an employee is required to provide service in exchange for an award, which often is the vesting period. Compensation expense is recognized only for those awards expected to vest. All stock-based compensation expense is classified within selling, general and administrative expense in the consolidated statements of operations. We do not believe there is a reasonable likelihood there will be a material change in the future estimates or assumptions we use to determine stock-based compensation expense. A 1% change in our stock-based compensation expense for the year ended December 31, 2013, would have affected net income by approximately $60,000.
In July 2013, the FASB issued guidance which states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available as of the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014, with early adoption permitted. We plan to adopt this guidance during the quarter ended March 31, 2015 and are assessing the potential impact to our consolidated financial statements.
In February 2013, the FASB issued guidance that expanded disclosures for items reclassified out of accumulated other comprehensive income (loss). The standard requires presentation of information about reclassification adjustments from accumulated other comprehensive income (loss) in a single note to or on the face of the financial statements. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. We plan to adopt the guidance during the quarter ended March 31, 2014, and do not expect it to have a significant impact our consolidated financial statements.