Our commission revenue generally represents a percentage of the insurance premium a member has paid to his or her insurance carrier and, to a 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 also can vary based upon the amount of time that the policy has been active, with commission rates for individual and family policies typically being higher in the first twelve months of the policy. 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 us our commissions 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 revenue is recurring in nature and has grown in correlation with the growth we have experienced in our membership base.
Revenue attributable to individual and family product offerings represented approximately 85%, 88% and 91% of our commission revenue in the years ended December 31, 2007, 2008 and 2009, respectively. We define
individual and family product offerings as major medical individual and family health insurance plans, which does not include small business, short-term major medical, stand-alone dental, life and student health insurance product offerings.
Marketing Partners. Our marketing partner member acquisition channel consists of consumers who access our website through a network of affiliate partners and financial services and other companies. Growth in our marketing partner channel depends upon our expanding marketing programs with existing partners and adding new partners to our network. For the years ended December 31, 2007, 2008 and 2009, applications submitted through us for individual and family health insurance products from our marketing partner member acquisition channel constituted approximately 31%, 33% and 32%, respectively, of all individual and family health insurance applications submitted on our website.
We entered into customer transition and marketing agreements with HBDC in February 2009. Pursuant to the agreements, HBDC agreed to transfer certain of its existing health insurance members to us as the new broker of record on the underlying policies and agreed to refer future health insurance prospects to us. We paid HBDC initial consideration of $1.3 million, which is being amortized to cost of revenue-sharing expense as we recognize commission revenue related to the transferred members. In addition, we agreed to pay HBDC a percentage of the commission revenue we receive on the transferred policies, as well as a percentage of the future commission revenue we receive on health insurance policies we sell to prospects HBDC refers to us. The ongoing revenue-sharing payments are also recognized as cost of revenue-sharing expense. During the year ended December 31, 2009, we became the broker of record on and recognized commission revenue from members transferred from HBDC, all of which were members on individual and family major medical policies. We expect cost of revenue-sharing expenses to decrease in absolute dollars in 2010 compared to 2009 as a result of an expected decrease in the amount of revenue-sharing payments we will make to HBDC due to a decline in the number of commission-generating members that were transferred to us from HBDC during 2009, and due to a decrease in amortization expense related to the initial consideration paid to HBDC.
Marketing and advertising expenses consist primarily of member acquisition expenses associated with our direct, marketing partner and online advertising member acquisition channels, in addition to compensation and other expenses related to marketing, business development, partner management, public relations and carrier relations personnel who support our offerings. Our direct channel expenses primarily consist of television advertising, radio advertising, print advertising, direct mail, email and other activities that drive consumers directly to our website.
Technology and content expenses consist primarily of compensation and benefits costs for personnel associated with developing and enhancing our website technology as well as maintaining our website. A majority of our technology and content group is located at our wholly owned subsidiary in China, where technology development costs are generally lower than in the United States. We expect technology and content expenses to increase in absolute dollars in 2010 compared to 2009 due to our continued focus on technology development, including the enhancement of our current ecommerce platform for Medicare product capabilities.
General and administrative expenses include compensation and benefits costs for staff working in our executive, finance, corporate development, investor relations, government relations, legal, human resources, internal audit, facilities and internal information technology departments. These expenses also include fees paid for outside professional services, mainly for audit, tax, legal and information technology consulting. We expect our general and administrative expenses to increase in absolute dollars in 2010 compared to 2009 due to the increased costs necessary to support the growth of our business.
The following table shows certain selected quarterly metrics for 2008 and 2009:
(6) Calculated as total 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 products for the period, divided by two). Ending membership includes an estimated 20,000 members transferred from Health Benefits Direct Corporation during 2009, net of estimated cancelations since their transfer.
(8) Estimated number of members active on all insurance policies as of the date indicated. Amounts as of December 31, 2009 include an estimated 20,000 members transferred from Health Benefits Direct Corporation during 2009, net of estimated cancelations since their transfer.
(11) Percentage of IFP submitted applications from applicants who came directly to the eHealth website through algorithmic search engine results or otherwise. See note (2) above for further information as to what constitutes a submitted application.
(13) Percentage of IFP submitted applications from applicants sourced through paid search and other online advertising activities. See note (2) above for further information as to what constitutes a submitted application.
(14) Calculated as marketing and advertising expenses for the period (see note (9) above) divided by the number of individuals on IFP applications submitted on eHealth’s website during the period. This metric may not reflect the true acquisition cost.
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 the useful lives of long-lived assets including property and equipment, fair value of investments, fair value of intangible assets, allowances for commission forfeitures payable to carriers, income taxes, the assumptions used in determining stock-based compensation and our assessment whether internal use software and website development costs will result in additional functionality, among others. We based 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. 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.
Our insurance carrier partners bill and collect insurance premiums that our members pay. We rely on health insurance carriers to report accurately and in a timely manner the amount of commissions earned by us, and we calculate our commission revenues, prepare our financial reports, projections and budgets, and direct our marketing and other operating efforts based on the reports we receive from them. Each month we analyze the reports we receive from our carriers by comparing such data to the database we maintain on our members. It is often difficult for us to independently determine whether or not carriers are reporting all commissions due to us, primarily because the majority of our members who terminate their policies do so by discontinuing their premium payments to the carrier instead of by informing us of the cancellation. Also, some of our members pay their premiums less frequently than monthly. This results in our having to identify underpayment or non-payment of commissions on a policy and follow up with a carrier to obtain an explanation and/or request correction of the amount of commissions paid to us. To date, we have not had disputes of any significance with carriers related to reported commissions. To the extent that carriers understate or fail to timely and accurately report or pay the amount of commissions due to us, we will not collect and recognize revenue to which we are entitled, which, if material in amount, would adversely affect our operating results and financial condition.
Certain commission amounts are subject to forfeiture in circumstances where a member has prepaid his or her premium for a future period of coverage and subsequently cancels his or her policy before the completion of that period. We estimate and record an allowance for these forfeitures based on historical cancellation experience using data provided on commission statements. The forfeitures are typically reported to us by health insurance carriers one to two months after the commission is reported and paid to us by the carrier. Our estimate of the allowance for forfeitures includes an estimate of both the reporting time lag and the forfeiture amount. 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, 2007, 2008 and 2009 which had a material impact on our allowance for forfeitures.
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.
In September 2008, the state of California approved its budget for fiscal year ending June 30, 2009, which contained changes to the California tax law which substantially limited our ability to utilize available state net operating loss and tax credit carry forwards to reduce our state income taxes payable. Under the new tax law, the utilization of net operating loss carry forwards was suspended for tax years 2008 and 2009; however, the expiration date of the net operating loss carry forwards was extended for an equivalent two-year period. Additionally, for tax years 2008 and 2009, taxpayers may only utilize available tax credit carry forwards to reduce their current tax liability up to 50% of their net tax amount before application of such credits. The new law does not affect the amount of net operating loss or tax credit carry forwards that we expect to ultimately use to offset future California taxes; however, it did limit the amount of net operating loss and tax credit carry forwards that we were able to utilize to reduce our taxes payable during 2008 and 2009, resulting in an increase in cash taxes paid to the state of California in 2008 and 2009. While this change in the California tax law did not impact our effective tax rate, our cash outlay for federal and state taxes increased to approximately 11% of pre-tax income in 2009 compared to 1% of pre-tax income 2008 and is expected to be approximately 3% to 5% of pre-tax income in 2010 assuming the state of California does not extend the suspension of the utilization of net operating loss carry forwards.
Due to the restriction on our ability to utilize net operating loss carry forwards to reduce taxes currently payable in California as well as the expected utilization of our remaining federal net operating losses during 2008 and 2009, we utilized excess tax benefits related to share-based payments and other unrecognized tax benefits, which increased additional paid-in capital in the consolidated balance sheets $0.3 million and $5.0 million as of December 31, 2008 and 2009, respectively, and increased other non-current liabilities in the consolidated balance sheets $0.4 million and $2.4 million as of December 31, 2008 and 2009, respectively. Additionally, the realized excess tax benefits related to share-based payments in 2008 and 2009 are classified in the consolidated statements of cash flows as both a financing cash inflow and an operating cash outflow. We expect to continue utilizing excess tax benefits related to share-based payments and other unrecognized tax benefits in 2010.
2008 compared to 2007-Commission revenue increased $19.3 million, or 24%, in 2008 compared to 2007, primarily due to an increase in our membership. Our estimated membership increased approximately 20% to 621,100 at December 31, 2008 from 518,400 at December 31, 2007. Sponsorship, licensing and other revenue increased $4.6 million, or 73%, in 2008 compared to 2007, primarily due to increased sales of carrier sponsorship advertising on our website and, to a lesser extent, new licensing arrangements related to our technology.
Based on information currently available to us, we expect total revenue to increase in absolute dollars in 2010 compared to 2009 as a result of continued growth in our membership as well as growth in our sponsorship and licensing businesses.
We expect our cost of revenue-sharing expenses to decrease in absolute dollars in 2010 compared to 2009 as a result of an expected decrease in the amount of revenue-sharing payments we will make to HBDC due to a decline in the number of commission-generating members that were transferred to us from HBDC during 2009, and due to a decrease in amortization expense related to the initial consideration paid to HBDC.
The following table presents our marketing and advertising expenses for the years ended December 31, 2007, 2008 and 2009 and the dollar and percentage change from the prior year (dollars in thousands):
2008 compared to 2007-Marketing and advertising expenses increased $12.7 million, or 43%, in 2008 compared to 2007. This was primarily due to an increase in our online advertising expenses of $7.0 million resulting from an increase in paid keyword search advertising costs on Internet search engines, as the cost of and volume of click-throughs from the online advertising channel increased during 2008 compared to 2007.
Marketing partner expenses increased $3.7 million due to an increase in the costs per application and the growth in the number of applications submitted on our website through the marketing partner channel during 2008 compared to 2007. Additionally, direct advertising expenses increased $1.2 million as a result of television, radio and other marketing initiatives we undertook during the year. Finally, compensation and benefit costs of marketing and advertising personnel increased $0.5 million. Our acquisition cost per member increased 20% to $61.68 in 2008 from $51.30 in 2007. This increase was primarily due to the increases in online advertising expenditures, television and radio advertising expenditures and an increase in marketing partner channel expenses. As a percentage of total revenue, total marketing and advertising expenses increased to 38% in 2008 from 34% in 2007.
We expect our marketing and advertising expenses to increase in absolute dollars in 2010 compared to 2009 due to an increase in our online marketing and advertising expenditures during 2010, including paid keyword search advertising. As a result, we expect the average cost of acquiring new members to be higher in 2010 compared to 2009. As a percentage of total revenue in 2010, we expect our marketing and advertising expense to be equal to or higher than our 2009 expense as a percentage of total revenue. Our cost of acquisition depends significantly on the rate at which visitors to our website submit health insurance applications, particularly with respect to paid search advertising, as our paid search costs are incurred on the referral of a potential member rather than on the submission of a health insurance application. Other factors that may impact the average cost of acquiring new members include the mix of health insurance applications submitted through our three member acquisition channels, the mix of marketing partners referring consumers to our website, the overall trend in costs of online marketing, seasonality patterns, the amounts we pay marketing partners to refer consumers to our website, television and radio advertising expenditures, and an increase in compensation and benefits costs attributable to marketing and advertising personnel. We may also explore new marketing initiatives that increase per member acquisition costs as part of our efforts to drive more consumers to our website.
The following table presents our customer care and enrollment expenses for the years ended December 31, 2007, 2008 and 2009 and dollar and percentage change from the prior year (dollars in thousands):
The following table presents our technology and content expenses for the years ended December 31, 2007, 2008 and 2009 and dollar and percentage change from the prior year (dollars in thousands):
2009 compared to 2008- Technology and content expenses increased $1.5 million, or 11%, in 2009 compared to 2008. This increase was primarily due to an increase of $0.9 million in compensation and benefits costs associated with an increase in technology and content personnel. Additionally, depreciation expense increased $0.3 million due to purchases of computer hardware and software related to our website and stock-based compensation costs increased $0.3 million due to additional equity grants to employees. As a percentage of total revenue, technology and content costs decreased to 12% in 2009 from 13% in 2008 as a result of economies of scale achieved by our technology and content operations.
2008 compared to 2007-Technology and content expenses increased $1.8 million, or 14%, in 2008 compared to 2007. This increase was primarily due to a $0.4 million increase in compensation and benefit costs associated with an increase in the number of personnel necessary to develop and maintain our technology and website content. Stock-based compensation costs increased $0.3 million due to additional equity grants to employees. Data center expenses increased $0.3 million due to a new lease for data center space, as well as new maintenance agreements for hardware and software. As a percentage of total revenue, technology and content costs decreased to 13% in 2008 from 14% in 2007 as a result of economies of scale achieved by our technology and content operations in 2008.
The following table presents our general and administrative expenses for the years ended December 31, 2007, 2008 and 2009 and dollar and percentage change from the prior year (dollars in thousands):
expense increased $1.1 million due to additional equity grants to employees and directors. Partially offsetting these increases were decreases in legal and accounting fees of $0.5 million and $0.4 million, respectively. As a percentage of total revenue, general and administrative expenses decreased to 16% in 2008 from 18% in 2007.
We expect our general and administrative expenses to increase in absolute dollars in 2010 compared to 2009 due to the increased costs necessary to support the growth of our business.
The following table presents our interest and other income, net, for the years ended December 31, 2007, 2008 and 2009 and the dollar and percentage change from the prior year (dollars in thousands):
2008 compared to 2007-Interest and other income, net, decreased $1.6 million, or 30%, in 2008 compared to 2007, primarily due to a decline in the average yield earned on our invested cash, cash equivalents and marketable securities during the year ended December 31, 2008 compared to the year ended December 31, 2007. Interest income totaled $3.9 million and $5.4 million for the years ended December 31, 2008 and 2007, respectively. Cash, cash equivalents and marketable securities increased from $121.5 million at December 31, 2007 to $150.6 million at December 31, 2008 primarily from cash generated from operations and net proceeds from the exercise of common stock options. As a percentage of total revenue, interest and other income, net decreased to 3% in 2008 from 6% in 2007.
We expect interest and other income, net, to amount to less than 1% of total revenue in 2010 as a result of the decline in the average yield we earn on our invested cash, cash equivalents and marketable securities.
2009-In 2009, we recorded a provision for income taxes of $11.4 million, representing an effective tax rate of 42.7% for 2009. 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 benefit 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.
New California tax legislation limited our ability to utilize net operating loss and tax credit carry forwards to reduce our state income taxes payable in 2009. As a result, our cash outlay for taxes payable to the state of California increased in 2009 compared to 2008.
2007-In the fourth quarter of 2007, we concluded, based upon recent operating results, expectations of future taxable income, available carry forward periods and other factors, that it was more likely than not that we will realize sufficient earnings to utilize all of our deferred tax assets. Accordingly, we reversed the remaining valuation allowance against deferred tax assets and recorded a tax benefit of $18.9 million. This benefit was partially offset by a provision for income taxes of $8.6 million for 2007.
At December 31, 2009, our cash, cash equivalents and marketable securities totaled $153.5 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. Marketable securities are comprised primarily of available-for-sale financial instruments with original maturities of more than 90 days but less than two years from the date of purchase. Marketable securities that are available for use in current operations are classified as current assets in the accompanying consolidated balance sheets regardless of the remaining time to maturity.
On November 12, 2008, we announced that our board of directors authorized a stock repurchase program, pursuant to which up to 2,507,950 shares could be repurchased, for a total cost not to exceed $30 million. Share repurchases under this program complied with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. The stock repurchase program was completed in September 2009 when a cumulative balance of approximately $30 million of common stock, including commissions, had been repurchased. We funded the stock repurchase program from available working capital. Repurchased shares are held in treasury and are accounted for using the cost method. As of December 31, 2009, we had repurchased 1,877,850 shares under the program at an average cost of $15.97 per share for a total cost of $30 million.
Cash provided by operating activities primarily consists of net income, adjusted for certain non-cash items including deferred income taxes, depreciation and amortization, amortization and accretion on marketable securities, net, stock-based compensation expense, excess tax benefits from stock-based compensation, and the effect of changes in working capital and other activities.
2008-Our operating activities generated cash of $30.2 million during the year ended December 31, 2008 and consisted of net income of $14.2 million adjusted by non-cash items of $14.5 million and cash provided by working capital and other activities of $1.5 million. Adjustments for non-cash items primarily consisted of $9.5 million of deferred income taxes, $3.5 million of stock-based compensation expense and $1.9 million of depreciation and amortization. Cash provided by working capital and other activities primarily consisted of an increase of $0.7 million in accrued marketing expenses, an increase of $0.7 million in accounts payable and an increase of $0.6 million in other current liabilities, partially offset by an increase of $0.7 million in accounts receivable.
During the years ended December 31, 2008 and 2009, due to the restriction on our ability to utilize net operating loss carry forwards to reduce taxes currently payable in California, we utilized excess tax benefits related to share-based payments, which resulted in a $0.3 million decrease in cash generated from operating activities and a $0.3 million increase in cash generated from financing activities during 2008, and a $5.0 million decrease in cash generated from operating activities and a $5.0 million increase in cash generated from financing activities during 2009. We expect to continue utilizing excess tax benefits related to share-based payments in 2010, which will reduce our cash generated from operating activities and increase our cash generated from financing activities in 2010. Additionally, primarily as a result of the recent change in the California tax law, our cash outlay for federal and state taxes was approximately 11% of pre-tax income for 2009 and is expected to be approximately 3% to 5% of pre-tax income for 2010 assuming the state of California does not extend the suspension of the utilization of net operating loss carry forwards.
activities primarily consisted of an increase of $1.0 million in accrued compensation and benefits, an increase of $0.8 million in accrued marketing expenses, an increase in other current liabilities of $0.4 million and an increase of $0.4 million in deferred revenue, partially offset by an increase of $0.6 million in accounts receivable and an increase of $0.5 in other assets.
Our investing activities primarily consist of purchases, sales and maturities of marketable securities and purchases of computer hardware and software to enhance our website and to support our growth. Marketable securities generally consist of investment grade corporate and U.S. government-sponsored enterprise debt securities, commercial paper and certificates of deposit that have a maturity of more than 90 days but less than two years from the date of purchase and are available for use in current operations. These investments are carried at fair value with unrealized gains and losses, net of taxes, reported as a component of stockholders’ equity in the consolidated balance sheets and in comprehensive income on the consolidated statements of income and comprehensive income.
2009-Net cash used in financing activities of $23.6 million during 2009 was primarily due to $29.4 million used to repurchase 1,827,193 shares of our common stock, partially offset by $5.0 million of non-cash excess tax benefits from stock-based compensation and $0.9 million of net proceeds received from the issuance of common stock pursuant to stock option exercises.
During 2009, we extended the operating lease for our facility in San Francisco, California for an additional five years, expiring in October 2014, extended the operating leases for our headquarter facilities in Mountain View, California for an additional year, expiring in August 2010, and expanded the operating lease for our facility in China to include additional office space.
In December 2008, we entered into a capital lease agreement for office equipment which expires in April 2012.
We have entered into service and licensing agreements with third-party vendors to provide various services, including website development, website hosting, network access, data center services and software licensing. The terms of these services and licensing agreements are generally up to three years, the latest of which expires in November 2011. We record the related service and licensing expenses on a straight-line basis, although actual cash payment obligations under certain of these agreements fluctuate over the terms of the agreements.
We have audited the accompanying consolidated balance sheets of eHealth, Inc. as of December 31, 2009 and 2008, 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, 2009. 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.
As discussed in Note 1 to the consolidated financial statements, eHealth, Inc. changed its method of accounting for uncertain tax positions as of January 1, 2007.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), eHealth, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 5, 2010 expressed an unqualified opinion thereon.
Description of Business-eHealth, Inc. (the “Company,” “eHealth,” “we” or “us”) offers Internet-based insurance agency services for individuals, families and small businesses in the United States, as well as technology licensing and Internet advertising services. Our services and technology enable individuals, families and small businesses to research, analyze, compare and purchase health insurance products from health insurance carriers across the nation. We are licensed to market and sell health insurance in all 50 states and the District of Columbia.
Subsequent Events Evaluation-We have reviewed and evaluated material subsequent events from the balance sheet date of December 31, 2009 through the date of issuance of these financial statements. No subsequent events have been identified for disclosure.
taxes, reported as a component of accumulated other comprehensive income in the accompanying consolidated balance sheets. Realized gains and losses on marketable securities are recognized in earnings as a component of interest and other income, net in the consolidated statements of income and comprehensive income. The cost of investments sold is based on the specific identification method.
Fair Value of Financial Instruments-The carrying amounts of our financial instruments, including cash and cash equivalents, marketable securities, accounts receivable, accounts payable and accrued liabilities (including accrued compensation and benefits, accrued marketing expenses and other current liabilities), approximate fair value because of their short maturities. The carrying amounts of our capital leases approximate the fair value of these obligations based upon our best estimates of interest rates that would be available for similar debt obligations at December 31, 2009.
(1) At December 31, 2008 and 2009, money market accounts invested primarily in U.S. government-sponsored enterprise bonds and discount notes, U.S. government treasury bills and notes and repurchase agreements collateralized by U.S. government obligations.
We do not require collateral or other security for our accounts receivable. As of December 31, 2009, two carriers represented $0.9 million, or 39%, of our total accounts receivable. No other carrier represented 10% or more of our total accounts receivable. We believe the potential for collection issues with any of our carriers is minimal. Accordingly, our allowance for uncollectible accounts at December 31, 2009 was not material.
Substantially all revenue for all years presented was generated from customers located in the United States. The following carriers (or carriers owned by them) represented 10% or more of our total revenue for the years ended December 31, 2007, 2008 and 2009:
Partnership with Health Benefits Direct Corporation-In February 2009, we entered into customer transition and marketing agreements with Health Benefits Direct Corporation, or HBDC. Pursuant to these agreements, HBDC agreed to transfer certain of its existing health insurance members to us as the new broker of record on the underlying policies and agreed to refer future health insurance prospects to us. We paid HBDC initial consideration of $1.3 million, which is being amortized to cost of revenue-sharing expense as we recognize commission revenue related to the transferred members. In addition, we agreed to pay HBDC a
percentage of the commission revenue we receive on the transferred policies, as well as a percentage of the future commission revenue we receive on health insurance policies we sell to prospects HBDC refers to us. The ongoing revenue-sharing payments are recognized as cost of revenue-sharing expense when we recognize the related revenue.
Seasonality-The number of 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 in 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 website, those expenses are influenced by these seasonal patterns.
In addition to the commission revenue we derive from the sale of health insurance products, we derive revenue from our online sponsorship advertising program and from licensing the use of our ecommerce technology. Our sponsorship advertising program allows carriers to purchase advertising space in specific markets in a sponsorship area on our website. In return, we are typically paid a monthly fee, which is recognized over the period that advertising is displayed, and often a performance fee based on metrics such as submitted health insurance applications. Our technology licensing business allows carriers the use of our ecommerce platform to offer their own health insurance policies on their websites and agents to utilize our technology to power their online quoting, content and application submission processes. Typically, we are paid a one-time implementation fee, which we recognize on a straight-line basis over the estimated term of the customer relationship (generally the initial term of the agreement), commencing once the technology is available for use by the third party, and a performance fee based on metrics such as submitted health insurance applications. The metrics used to calculate performance fees for both sponsorship advertising and technology licensing are based on performance criteria that are either measured based on data tracked by us, or based on data tracked by the third party. In instances where the performance criteria data is tracked by us, we recognize revenue in the period of performance. In instances where the performance criteria data is tracked by the third party, we recognize revenue when the amounts earned are both fixed and determinable and collection is reasonably assured. Typically, this occurs through our receipt of a cash payment from the third party along with a detailed statement containing the data that is tracked by the third party.
Cost of Revenue-Sharing-Cost of revenue-sharing consists primarily of payments related to health insurance policies sold to members who were referred to our website by marketing partners with whom we have revenue-sharing arrangements. Costs related to revenue-sharing arrangements are expensed at the time the related revenue is recognized. Cost of revenue-sharing also includes costs related to the initial consideration we paid to HBDC pursuant to the customer transition and marketing agreements we entered into, which is being amortized to cost of revenue-sharing expense in the consolidated statements of income and comprehensive income as we recognize commission revenue related to the transferred members.
Marketing and Advertising-Marketing and advertising expenses consist primarily of member acquisition expenses associated with our direct, marketing partner and online advertising channels, in addition to compensation, benefits and other expenses related to marketing, business development, partner management, public relations and carrier relations personnel who support our offerings. We report the cost of advertising as expense in the period in which costs are incurred.
Occasionally we participate in cooperative advertising programs with certain of our partners whereby they reimburse us for a portion of our advertising costs. The amounts our partners will reimburse us for advertising are typically determined at the beginning of each year and we are able to choose when to advertise and receive the related reimbursement throughout the year.
Technology and Content-Technology and content expenses consist primarily of compensation and related expenses for personnel associated with developing and enhancing our website technology as well as maintaining our website. A portion of our technology and content group is located at our wholly owned subsidiary in China, where technology development costs are generally lower than in the United States.
Stock-Based Compensation-We recognize stock-based compensation expense in the accompanying consolidated statements of income and comprehensive income based on the estimated fair value of our stock-based awards over their respective vesting periods, which is generally four years. The estimated grant date fair value of our stock-based awards is determined using the Black-Scholes-Merton pricing model and a single option award approach. The weighted-average expected term for stock options granted is calculated using the simplified method, as we do 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 have 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. We estimate our expected volatility using the weighted-average of: our implied volatility; our mean reversion volatility; and the mean reversion volatility of similar public companies for which we have data. We have used judgment in selecting these companies, as well as evaluating the available historical and implied volatility data for these companies. The dividend yield is determined by dividing the expected per share dividend during the coming year by the grant date stock price. Through December 31, 2009, 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 management’s 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.
Comprehensive Income-All components of comprehensive income, including net income, are reported in our consolidated financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources (primarily foreign currency translation gains and losses and unrealized gains and losses on cash equivalents and marketable securities). Statements of comprehensive income have been included within the accompanying consolidated statements of income and comprehensive income.
Net Income Per Share-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 equivalent shares outstanding during the period. Potentially dilutive securities, composed of incremental common shares issuable upon the exercise of stock options, are included in diluted net income per share to the extent such shares are dilutive.
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, 2007, 2008 and 2009, 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. As of December 31, 2008 and 2009, there were 25,040,935 shares and 23,416,730 shares of common stock outstanding, respectively.
(1) Shares available for grant exclude treasury stock of 54,454 shares and 1,894,355 shares at December 31, 2008 and 2009, respectively, that could be granted if eHealth determined to do so.
(3) The 1998 and 2005 Stock Plans were terminated with respect to the grant of additional shares upon the effective date of the registration statement related to our initial public offering in October 2006, resulting in reductions in the total number of shares authorized for issuance.
Total intrinsic value of stock options exercised during the years ended December 31, 2007, 2008 and 2009 was $62.0 million, $7.9 million and $1.4 million, respectively.
Unrecognized stock-based compensation expense, net of estimated forfeitures, was $11.0 million as of December 31, 2009 and will be amortized on a straight-line basis over the remaining weighted average vesting term of the underlying equity awards which was approximately 2.6 years as of December 31, 2009. Unrecognized stock-based compensation will be adjusted for subsequent changes in estimated forfeitures.
The fair value of stock options granted to employees for the years ended December 31, 2007, 2008 and 2009 was estimated using the following weighted average assumptions:
The following table summarizes information about stock options outstanding as of December 31, 2009 (in thousands, except per share amounts and weighted average remaining contractual life data):
On November 12, 2008, we announced that our board of directors authorized a stock repurchase program, pursuant to which up to 2,507,950 shares could be repurchased, for a total cost not to exceed $30 million. Share repurchases under this program complied with Rule 10b-18 under the Securities Exchange Act of 1934, as
amended. The stock repurchase program was completed in September 2009 when a cumulative balance of approximately $30 million of common stock, including commissions, had been repurchased. For accounting purposes, common stock repurchased under the program was recorded based upon the settlement date of the applicable trade. Repurchased shares are held in treasury and are accounted for using the cost method. The stock repurchase activity under the stock repurchase program during the year ended December 31, 2009 is summarized as follows (in thousands, except share and per share amounts):
As of December 31, 2009, all stock repurchases under the stock repurchase program were made on the open market. In addition to the 1,877,850 shares repurchased under our stock repurchase program as of December 31, 2009, we have in treasury 16,505 shares that were surrendered by employees to satisfy tax withholdings due in connection with the vesting of certain restricted stock units. As of December 31, 2008 and 2009, we had a total of 54,454 shares and 1,894,355 shares, respectively, held in treasury.
Historically, we had provided a valuation allowance against the net deferred tax assets to reflect these uncertainties. At the end of 2007, we developed expectations of future taxable income and other relevant factors sufficiently in the future to conclude that it was more likely than not that we would realize sufficient earnings to utilize all of our deferred tax assets. Accordingly, we reversed our $18.9 million valuation allowance against deferred tax assets in the fourth quarter of 2007. Our effective tax rate in 2007 differed from the statutory federal
At December 31, 2009, we had tax credit carry forwards of approximately $3.2 million and $0.5 million for federal income tax and state income tax purposes, respectively. Federal tax credit carry forwards begin expiring in 2020 and state tax credits carry forward indefinitely. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
As of December 31, 2008 and 2009, there were $2.2 million and $2.4 million, respectively, of unrecognized tax benefits, that, if recognized, would impact the effective tax rate. Due to net operating losses, all tax years after 1998 are open to examination and adjustment.
We consider the foreign earnings of our China subsidiary to be indefinitely reinvested outside the United States. Our China subsidiary has incurred cumulative net losses since inception. Accordingly, we have not provided U.S. taxes on the cumulative foreign earnings of our China subsidiary.
Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding for the fiscal period. Diluted net income per share is computed giving effect to all potential dilutive common stock, including options, restricted stock and restricted stock units. The dilutive effect of outstanding awards is reflected in diluted earnings per share by application of the treasury stock method.
Service and Licensing Agreements-We have entered into service and licensing agreements with third-party vendors to provide various services, including website development, website hosting, network access, data center services and software licensing. The terms of these services and licensing agreements are generally up to three years, the latest of which expires in November 2011. We record the related service and licensing expenses on a straight-line basis, although actual cash payment obligations under certain of these agreements fluctuate over the terms of the agreements.
As of December 31, 2009, future cash payment commitments for services provided in connection with these agreements were as follows (in thousands):
Guarantees and Indemnifications-We have agreed to indemnify members of our board of directors and our executive officers for fees, expenses, judgments, fines and settlement amounts incurred in any action or proceeding, including actions or proceedings by or in the right of the Company, to which any of them is, or is threatened to be, made a party by reason of their service as a director or officer of the Company or service provided to another company or enterprise at our request. The term of the director and officer indemnification is perpetual as to events or occurrences that take place while the director or officer is, or was, serving at our request. As such, the maximum potential amount of future payment we could be required to make under these indemnification arrangements is unlimited. We, however, maintain directors and officers insurance coverage that limits our exposure under certain circumstances and that may allow us to recover a portion of future amounts paid. We believe the estimated fair value of these indemnification agreements is minimal. Accordingly, we have not recorded any liabilities for these agreements as of December 31, 2008 or 2009.
Geographic Information-Substantially all revenue for all years presented was generated from customers located in the United States. As of December 31, 2008 and 2009, our long-lived assets consisted primarily of property and equipment and indefinite-lived intangible assets. Our long-lived assets are attributed to the geographic location in which they are located. Long-lived assets by geographical area were as follows (in thousands):