As of December 31, 2017, we leased facilities in four different cities throughout the U.S. All properties are leased with various expiration dates. Our locations are summarized as follows:
Health Insurance Innovations, Inc. is a Delaware corporation incorporated on October 26, 2012. In this management's discussion and analysis, unless the context suggests otherwise, references to the “Company,” “we,” “us” and “our” refer (1) prior to our February 13, 2013 initial public offering (“IPO”) of the Class A common stock of Health Insurance Innovations, Inc., to Health Plan Intermediaries, LLC (“HPI”) and Health Plan Intermediaries Sub, LLC (“HPIS”), its consolidated subsidiary, and (2) after the IPO, to Health Insurance Innovations, Inc. and its consolidated subsidiaries. The terms “HIIQ” and “HPIH” refer to the stand-alone entities Health Insurance Innovations, Inc., and Health Plan Intermediaries Holdings, LLC, respectively. The terms “HealthPocket” or “HP” refer to HealthPocket, Inc., our wholly owned subsidiary which was acquired by HPIH on July 14, 2014. The term “ASIA” refers to American Service Insurance Agency LLC, a wholly owned subsidiary which was acquired by HPIH on August 8, 2014. HPIH, HP and ASIA are consolidated subsidiaries of HIIQ.
The following table presents a reconciliation of premium equivalents to revenues for the years ended December 31, 2017 and 2016 ($ in thousands):
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.
The following table presents a reconciliation of net income to EBITDA and adjusted EBITDA for the years ended December 31, 2017 and 2016 ($ in thousands):
Adjusted net income. To calculate adjusted net income, we calculate net income then add back amortization (but not depreciation), interest, tax expense and other items that are not part of regular operating activities, including transaction costs, tax receivable agreement liability adjustment, severance, restructuring costs, and other non-cash items such as non-cash stock-based compensation. From adjusted pre-tax net income we apply a pro forma tax expense calculated at an assumed rate of 38% which consists of the maximum federal corporate rate of 35% with an assumed 3% state tax rate. 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.
The following table presents a reconciliation of net income to adjusted net income and adjusted net income per share for the years ended December 31, 2017 and 2016 (in thousands, except per share data):
(1) The year-over-year increase in non-GAAP weighted average diluted share count was driven by the increase in issued shares relating to stock appreciation rights exercises described in Note 8 of the accompanying consolidated financial statements.
Core SG&A. We define this metric as total GAAP selling, general, and administrative ("SG&A") expenses adjusted for stock-based compensation, severance, restructuring and other costs, and marketing leads and advertising expense. We have included Core SG&A in this report because it is a key measure used by our management to understand and evaluate our core operating performance and trends. Other companies may calculate this measure differently than we do. Core SG&A has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for SG&A as reported under GAAP.
We continue to receive a commission payment until the plan expires or is terminated. Accordingly, a significant portion of our monthly revenues is predictable on a month-to-month basis and revenues increase in direct proportion to the growth we experience in the number of policies in force.
Credit card and ACH fees for the year ended December 31, 2017 were $5.1 million, an increase of $1.2 million, or 29.5%, compared to 2016. The increase in credit card and ACH fees was in line with the increase in premium equivalents.
Credit card and ACH fees represented 2.0% and 1.3% of revenues and premium equivalents, respectively, for the year ended December 31, 2017, compared to 2.1% and 1.2% of revenues and premium equivalents, respectively, in 2016. These percentages are in line with our expectations.
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.
Depreciation and amortization expenses for 2017 were $4.0 million, an increase of $795,000 or 24.5%, compared to 2016. The increase in depreciation and amortization was primarily driven by depreciation of internal-use software.
The Company is evaluating the other provisions of the Act and does not believe that the other provisions will have a material impact on the consolidated financial statements, if any.
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 12 of the accompanying consolidated financial statements for further information on the TRA with the holders of HPIH Series B Membership Interests.
Other expense was $104,000 for the year ended December 31, 2017 and was comprised of approximately $48,000 of miscellaneous state tax expense other than income taxes, and approximately $56,000 in miscellaneous bank fees. For the year ended December 31, 2016, other expense was $5,000 from miscellaneous bank fees.
We are the sole managing member of HPIH and have 100% of the voting rights and control. As of December 31, 2017, we had a 76.3% economic interest in HPIH, whereas HPI and HPIS collectively held the remaining 23.7% economic interest in HPIH. HPI and HPIS’s interest in HPIH is reflected as a noncontrolling interest on our accompanying consolidated financial statements contained elsewhere in this report.
As of December 31, 2017, we had $39.3 million of cash and cash equivalents, excluding restricted cash.
The Credit Facility is secured by: (i) a first priority lien on substantially all of the assets (subject to certain excluded assets) of HPIH and certain of its affiliates (including the Company) and (ii) pledges of equity interests in the subsidiaries of the Company.
On May 5, 2017, the Company filed a registration statement on Form S-3, which was declared effective by the SEC on May 19, 2017, 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. Securities may be sold in one or more classes or series and in amounts, at prices and on terms that we will determine at the times of the offerings and we may offer the securities independently or together in any combination for sale directly to purchasers or through underwriters,
Our uses of cash in investing activities for the year ended December 31, 2017 included cash used to fund the development of internal-use software of $3.0 million and $509,000 to purchase property and equipment.
Through December 31, 2017, we had not entered into any off-balance sheet arrangements, other than the operating leases discussed in Note 12 of the accompanying consolidated financial statements.
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. We have elected under the JOBS Act to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates.
While performing the reporting unit’s impairment assessment we use, or have used, a combination of valuation approaches including the market approach and the income approach. The market approach uses a guideline company methodology, which is based upon a comparison of the reporting unit to similar publicly-traded companies within our industry. We derive a market value of invested capital or business enterprise value for each comparable company by multiplying the price per share of common stock of the publicly traded companies by their total common shares outstanding and adding each company’s current level of debt. We calculate a business enterprise multiple based on revenue and earnings from each company, then apply those multiples to our revenue and earnings to calculate a business enterprise value. Assumptions regarding the selection of comparable companies are made based on, among other factors, capital structure, operating environment and industry. As the comparable companies were typically larger and more diversified than our business, multiples were adjusted prior to application to our revenues and earnings to reflect differences in margins, long-term growth prospects and market capitalization.
If actual results differ substantially from the assumptions used in performing the impairment test, the fair value of the reporting units may be significantly lower, causing the carrying value to exceed the fair value and indicating an impairment has occurred. Absent offsetting changes in other factors, a 1% increase in the discount rate would decrease the estimated fair value of our reporting unit by approximately $11.0 million, but would not indicate impairment.
The allowance for advanced commissions represents management’s best estimate of probable losses inherent in the receivable balance. These estimates are based on a multiple calculation of expected payback period relative to term length of policy sold. In an effort to identify adverse trends for advanced commissions, we perform ongoing reviews of tranche level account balances and their respective payback period. The recovery of advanced commission balances are evaluated on an account-by-account basis.
Currently, we do not believe that we have a significant amount of risk relative to the allowance for advanced commissions. As a measure of sensitivity, a 10% change in the allowance would have a $18,000 and $45,000 in 2017 and 2016, respectively, effect on pre-tax earnings.
Significant management judgment is required in determining the period in which the reversal of a valuation allowance should occur. We considered all available evidence, both positive and negative, such as historical levels of income and future forecasts of taxable income, among other items, in determining whether a full or partial release of the valuation allowance was required. In addition, our assessments required us to schedule future taxable income in accordance with the applicable tax accounting guidance to assess the appropriateness of a valuation allowance which further required the exercise of significant management judgment.
If actual future Company earnings are materially less than forecasted or if other underlying assumptions differ materially, the Company may not have adequate future taxable income to realize the entirety of the recorded deferred tax assets.
Expense for stock-based compensation is recognized based upon estimated grant date fair value and is amortized over the service period of the awards using the accelerated method. We offer awards which vest based on service conditions, performance conditions or market conditions. For grants of stock appreciation rights and stock options, we apply the Black-Scholes option-pricing model, Monte Carlo Simulation, or a lattice model, depending on the vesting conditions, in determining the fair value of share-based payments to employees.
The models used incorporate various assumptions, including expected volatility and expected term. Volatility is calculated using the Company’s trading history. The expected term of awards granted is based on the Company’s best estimate and the use of the simplified method for “plain vanilla” awards under GAAP, where applicable. Accruals of compensation cost for an award with a performance condition shall be based on the probable outcome of that performance condition. Therefore, compensation cost shall be accrued if it is probable that the performance condition will be achieved and shall not be accrued if it is not probable that the performance condition will be achieved. Such judgments can significantly impact the timing and amount of expense recognized.
As a measure of sensitivity, a 1% change to our estimated forfeiture rate would have had an approximate $98,000 impact on our 2017 operating income compared to $15,000 in 2016. Our estimated forfeiture rates as of December 31, 2017 and 2016, were 7%. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to determine stock-based compensation expense.
We are involved in various lawsuits, claims, investigations, and proceedings that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated.
Significant judgment is required to determine both probability and the estimated amount. We review these provisions at least quarterly and adjust these provisions accordingly to reflect the impact of negotiations, settlements, rulings, updates from legal counsel, and other updated information.
For the year ended December 31, 2017, three carriers accounted for 54% of our premium equivalents compared to the three carriers who accounted for 60% of our premium equivalents at December 31, 2016. The Company anticipates that its premium equivalents in 2018 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 15 "Concentrations of Credit Risk and Significant Customers" of the accompanying consolidated financial statements for further information.