Management’s Discussion and Analysis of Financial Condition and Results of Operations below presents the Company’s operating results for each of the two years in the period ended December 31, 2015, and its financial condition as of December 31, 2015. Except for the historical information contained herein, this report and other written and oral statements that the Company makes from time to time contain forward-looking statements, which involve substantial known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of results to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. See the section of this report entitled “Special Note Regarding Forward-Looking Statements.” Among the factors that could cause actual results to differ materially are those discussed in “Risks Factors” in Item 1A of this report. In addition, the following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in connection with the information presented in the Company’s consolidated financial statements and the related notes to its consolidated financial statements included in Part IV of this report.
We are a developer, distributor, and virtual administrator of affordable cloud-based individual health and family insurance plans and supplemental products. In May 2015, we launched www.AgileHealthInsurance.com (“AHI”), an online direct-to-consumer website, primarily using internal resources at HP.
We collect premium equivalents upon the initial sale of the plan and then monthly upon each subsequent periodic payment under such plan. We receive most premium equivalents through online credit card or ACH processing. As a result, we have limited
As of December 31, 2015, we had 195,132 total plans in force, compared with 106,243 on December 31, 2014. For the year ended December 31, 2015, our premium equivalents and revenues were $175.8 million and $104.7 million, respectively, representing increases of 12.6% and 18.0% when compared to the year ended December 31, 2014. 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.
Adjusted gross margin. We define adjusted gross margin as revenue less third-party commissions and credit card and ACH fees. Adjusted gross margin does not represent, and should not be considered as, an alternative to revenues, as determined in accordance with GAAP. Adjusted gross margin 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-term and long-term operational plans. In particular, adjusted gross margin can provide a useful measure for period-to-period comparisons of our business. Adjusted gross margin 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.
Adjusted EBITDA. To calculate adjusted EBITDA, we calculate EBITDA, which is then further adjusted for items that are not part of regular operating activities, including acquisition costs, restructuring costs, contract termination costs, and other non-cash items such as non-cash stock-based compensation. Adjusted 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. We have presented adjusted EBITDA because we consider it an important supplemental measure of our performance and believe that it is frequently used by analysts, investors and other interested parties in the evaluation of companies. Other companies may calculate adjusted EBITDA differently than we do. Adjusted 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.
Adjusted net income. Adjusted net income is computed by subtracting depreciation (but not amortization of intangible assets) from adjusted EBITDA to determine adjusted pre-tax income, from which an assumed tax expense calculated at the 38% federal statutory rate is deducted. We have included adjusted net income in this annual 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 has limitations as an analytical tool, and you should not consider it in isolation or substitution for earnings per share as reported under GAAP.
(1) Adjusted net income per share is computed by dividing adjusted net income by the weighted average number of diluted Class A and total Class B shares for each period.
Our revenues primarily consist of commissions and fees earned for health insurance policies and supplemental products issued to members, enrollment fees paid by members, referral fees, fees for discount benefit plans, and administration fees paid by members as a direct result of our enrollment services, brokerage services or referral sales. Revenues reported by the Company are net of premiums remitted to insurance carriers and fees paid for discount benefit plans.
Depreciation and amortization expenses for 2015 were $3.0 million, an increase of $587,000, compared to 2014. The increase in depreciation and amortization was primarily driven by amortization of acquired intangible assets.
During the last quarter of the year ended December 31, 2015, the company committed to and communicated a plan to restructure its operations at ICE and Secured. The company determined certain processes and cost centers of ICE and Secured to be duplicative and recognized that efficiencies could be gained by leveraging these operations with other owned call centers. The reorganization is expected to improve profitability and scalability. As of December 31, 2015, the restructuring plan was communicated to employees and substantially complete.
In connection with the restructuring, the total amount expected to be incurred can be aggregated into six categories: severance, asset write off, lease cancellation, legal fees, travel, and miscellaneous expense. Estimated total costs expected to be incurred by category are as follows ($ in thousands):
In connection with the restructuring, intangible assets were reviewed for impairment and as a result of our assessment, we have recorded a loss on intangibles related to distributors of $878,000. This amount is included in the asset write off category above and the associated loss is included with restructuring expenses in consolidated statement of operations as selling, general and administrative expense. See Notes 5 and 8 of the accompanying audited financial statements for further information about our intangible assets and restructuring activities.
We acquired Secured and ASIA in July 2013 and August 2014, respectively. The consideration for these acquisitions included contingent consideration, payable upon the attainment of certain economic thresholds. This contingent consideration is payable in cash and is included as contingent consideration liability on the accompanying audited balance sheets. See Note 2 of the accompanying audited financial statements for further information on these acquisitions and the contingent consideration agreements therein.
For 2015, we recorded a benefit for income taxes of $1.9 million, reflecting an effective tax rate of 420.4%. For 2014, we incurred a provision for income taxes of $90,000, reflecting an effective tax rate of 17.5%. During 2015 and 2014, the effective tax rates were significantly impacted by a change in the valuation allowance provided against our deferred tax assets that was made as a result of obligations under the tax receivable agreement that will permit certain tax benefits to be realized. See Note 11 of the accompanying audited financial statements for further information on income taxes and the effective tax rates.
Net income attributable to HII for 2015 included HII’s share of its consolidated entities’ net loss and a provision for income taxes of $1.9 million. Net loss attributable to HII for 2014 included HII’s share of its consolidated entities’ net loss and a provision for income taxes of $90,000.
On August 15, 2014, we entered into an underwriting agreement with Raymond James & Associates, Inc., as the underwriter, and HPI and HPIS, as selling stockholders (the “Selling Stockholders”). Pursuant to the underwriting agreement and an exchange agreement (the “Exchange Agreement”) between the Company and holders of Series B Membership Interests in HPIH, under which holders of Series B Membership Interests may exchange Series B Membership Interests, together with an equal number of shares of our Class B common stock for shares of our Class A common stock on a one-for-one basis, we issued 1,725,000 shares of Class A common stock, at a public offering price of $12.15 per share ($11.54 per share, net of underwriting discounts), for net proceeds of $19.9 million. We immediately used these proceeds to acquire Series B Membership Interests, together an equal number of shares of our Class B common stock from HPI and HPIS. These Series B Membership Interests were immediately recapitalized into Series A Membership Interests in HPIH. The Selling Stockholders agreed to sell to the underwriter for resale all 1,725,000 shares of Class A common stock. No shares were sold by the Company in this offering. The sale by the Selling Stockholders was made pursuant to the registration statement on Form S-3. No other shares of Class A common stock have been issued or sold pursuant to the registration statement on Form S-3. See Note 9 of the accompanying consolidated financial statements for more information on this transaction and the Exchange Agreement.
On December 15, 2014, we entered into the RLOC for $15.0 million with a bank. As of December 31, 2015, we have drawn $7.5 million against the line of credit primarily in support of expanding the advance commission program. The purpose of the RLOC is to provide working capital to support our general corporate expenses and to help us maintain adequate liquidity. Borrowings under the facility are secured by all of our and our subsidiaries’ assets, including, but not limited to, cash, accounts receivable, and property and equipment.
The following summary of cash flows for the periods indicated has been derived from our financial statements included elsewhere in this report.
The cash provided by operating activities during 2014 was $3.7 million. The primary causes of the adjustments to reconcile net income to net cash provided by operating activities were $2.4 million of depreciation and amortization of property and equipment and intangible assets, $1.1 million of fair value adjustment to the contingent consideration, and $2.5 million of stock-based compensation. The primary causes of the net change in operating assets and liabilities were an increase in accounts payable, accrued expenses and other liabilities by $3.9 million offset by an increase in advance commission loans to our distributors of $3.4 million and an increase in cash held on behalf of others of $1.3 million.
During the year ended December 31, 2015, cash provided by financing activities of $3.2 million was primarily attributable to proceeds received from borrowings under the RLOC of $7.5 million offset by payments of $2.6 million under contingent consideration obligations, distributions to members of $872,000 and purchases of treasury stock under our stock repurchase program of $520,000.
The purpose of the RLOC is to provide working capital to support our general corporate expenses, expand the advance commission program, and to help us maintain adequate liquidity. Borrowings under this facility are secured by all of our and our subsidiaries’ assets, including, but not limited to, cash, accounts receivable, and property and equipment. The stated interest rate for the RLOC is 30-day LIBOR, plus 1.95%. As of December 31, 2015, we have drawn $7.5 million against the RLOC primarily to support the expansion of the advance commission program.
The RLOC is subject to customary covenants and restrictions which, among other things, require us to maintain minimum working capital equal to 1.50 times the outstanding balance, and require that our maximum funded debt to tangible net worth ratio shall not exceed 1.50 at any time during the term of the RLOC. The RLOC also imposes certain nonfinancial covenants on us that would require immediate payment if we, among other things, reorganize, merge, consolidate, or otherwise change ownership or business structure without the bank’s prior written consent.
Under the terms of the RLOC, we incurred certain costs related to acquiring the RLOC of $23,000. These costs have been capitalized and are included in consolidated balance sheet at December 31, 2015. The financing costs consist primarily of consulting and legal fees directly related to the bank loan. These amounts are amortized over the life of the related debt. The unamortized balance as of December 31, 2015 was $15,000.
Our revenues consist primarily 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 include a combination of risk premium, fees for discount benefit plans 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, 2015 and December 31, 2014 was $352,000 and $159,000, respectively.
HP’s revenue is principally derived from referral and marketing fees, limited exclusivity fees, and landing page development fees. HP recognizes revenue when: (1) persuasive evidence exists of an arrangement with the customer reflecting the terms and conditions under which products or services will be provided; (2) delivery has occurred or services have been provided; (3) the fee is fixed or determinable; and (4) collection is reasonably assured.
Revenue is considered earned when the performance measures have been completed. Deposits (whether refundable or non-refundable), early payments and progress payments are not recognized as revenue until the revenue producing event has occurred.
Marketing fee revenue. HP offers marketing services over a specified term. This fee is related to telephone and website traffic received by HealthPocket.com for the customer and is recognized ratably over the life of the specified term of the marketing services. There are two ways marketing fee revenue is determined: lead fee revenue and conversion fee revenue. HP offers lead marketing services in the form of providing leads to customers. Revenue for leads provided is recognized based on the contractually agreed price per lead multiplied by the number of leads provided by HP during the period. HP offers conversion marketing services in the form of providing leads to customers with revenue recognized on a cost per acquisition basis. Revenue is calculated based on the number of qualifying conversions generated by HP leads. The customer collects conversion data and provides a contractually agreed periodical report to HP. Revenue is recognized based on the agreed price per lead conversion multiplied by the number of leads converted during the period.
As a result of our various acquisitions, we have recorded goodwill which represents the excess of the consideration paid over the fair value of the identifiable net assets acquired in a transaction accounted for as a business combination. An impairment test is performed by us at least annually as of October 1st of each year, or whenever events or circumstances indicate a potential for impairment.
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. The estimated fair value is then compared to the reporting unit’s carrying value. Upon completion of the analysis in step one as of October 1, 2015, we determined that the fair value of the reporting unit exceeded its carrying value. As such, a step two analysis was not required.
Our other intangible assets arose primarily from the acquisitions described above and consist of a brand, the carrier network, distributor relationships, customer relationships, noncompete agreements and capitalized software. Finite-lived intangible assets are amortized over their useful lives from two to fifteen years. Related to our restructuring, the company recognized an impairment of certain intangible assets in the amount of $878,000 for the year ended December 31, 2015. No impairments on intangible assets were recorded during the year ended December 31, 2014. See Notes 5 and 8 of the accompanying consolidated financial statements for further discussion on the impairment and restructuring activities.
HPIH is taxed as a partnership for federal income tax purposes; as a result, it is not subject to entity-level federal or state income taxation but its members are liable for taxes with respect to their allocable shares of each company’s respective net taxable income.
We are subject to U.S. corporate federal, state and local income taxes that are attributable to HII as reflected in our consolidated financial statements. We use the liability method of accounting for income taxes. Significant management judgment is required in determining the provision for income taxes and, in particular, any valuation allowance that is recorded or released against our deferred tax assets.
We evaluate quarterly the positive and negative evidence regarding the realization of net deferred tax assets. The carrying value of our net deferred tax assets is based on our belief that it is more likely than not that we will generate sufficient future taxable income to realize these 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 either service conditions or market conditions. For grants of SARs and stock options, we apply either the Black-Scholes option-pricing model or a lattice model, depending on the vesting conditions, in determining the fair value of share-based payments to employees. These models incorporate various assumptions, including expected volatility and expected term. Through November of 2015, expected stock price volatilities were estimated using implied volatilities of comparable publicly-traded companies, given our limited trading history. As of December 2015, 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.
Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability
In February 2015, the FASB issued an amendment to its accounting guidance related to financial statement consolidation. This guidance affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. Specifically, it modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting
In May 2014, the FASB issued an amendment to its accounting guidance related to revenue recognition. The amendment clarifies the principles for recognizing revenue. The guidance is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in the judgments and assets recognized from costs incurred to obtain or fulfill a contract. We will adopt this guidance in reporting periods beginning after December 15, 2018. We are currently evaluating the impact of adopting this pronouncement on our consolidated financial statements.