We are a leading developer, distributor, and virtual administrator of affordable health insurance plans, ancillary products. In July 2014, we acquired HealthPocket.com, a free website that compares and ranks health insurance plans available to an individual, family, or small business to allow consumers to make their best health plan decisions and reduce their out of pocket costs. HP uses only objective data from government, non-profit, and private sources that carry no condition that might restrict the site from serving as an unbiased resource.
Our sales of STM products are supplemented with additional production offerings. In addition to STM plans, we offer guaranteed-issue and underwritten 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, cancer/critical illness plans, and life insurance policies that are frequently purchased as supplements to STM and hospital indemnity plans. We also offer supplemental deductible and gap protection plans for consumers whose IMM plans may not cover certain medical expenses until high deductibles are met.
We design and structure these products on behalf of insurance carrier companies, market them to individuals through our internal and external distribution network. We 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.
Our scalable, proprietary, and web-based technology platform provides customers, whom we refer to as members, immediate access to the products we sell through our distribution partners. The health insurance products we develop are underwritten by insurance carrier companies, and we assume no underwriting, insurance or reimbursement risk. Members can tailor product selections to meet their personal insurance and budget needs, buy policies and print policy documents and identification cards in real-time. Our technology platform uses abbreviated online applications, some with health questionnaires, to provide an immediate accept or reject decision for products that we offer. Once an application is accepted, individuals can use our automated payment system to complete the enrollment process and obtain instant electronic access to their policy fulfillment documents, including the insurance policy, benefits schedule and identification cards. We receive credit card and ACH payments directly from members at the time of sale. Our technology platform provides operating leverage as we add members and reduces the costs associated with marketing, selling, underwriting and administering policies.
As the managing general underwriter of our individual health insurance plans and ancillary products, we receive all amounts due in connection with the plans we sell on behalf of the providers of the services. We refer to these total collections as premium equivalents, which typically represent a combination of premiums, fees for discount benefit plans (a non-insurance benefit product that supplements or enhances an insurance product), fees for distributors and our enrollment fees. From premium equivalents, we remit risk premium to carriers and amounts earned by discount benefit plan providers, who we refer to as third-party obligors, such carriers and third-party obligors being the ultimate parties responsible for providing the insurance coverage or discount benefits to the member. Our revenues consist of the balance of the premium equivalents.
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 accounts receivable. We remit the risk premium to the applicable carriers and the amounts earned by third-party obligors on a monthly basis based on the respective compensation arrangements.
As of December 31, 2014, we had 38,145 STM plans in force, compared with 28,709 on December 31, 2013. 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, 2014, our premium equivalents and revenues were $156.0 million and $88.8 million, respectively, representing increases of 56.0% and 56.7% when compared to the year ended December 31, 2013. For more detail about the use of premium equivalents as a business metric and a reconciliation of premium equivalents to revenues, see “Key Business Metrics-Premium Equivalents” below.
We acquired HealthPocket in July 2014. HealthPocket provides consumers with access to its leading health insurance information search and comparison technology through its website, HealthPocket.com. This free website allows consumers to easily and clearly compare and rank all health insurance plans available for an individual, family, or small business, empowering consumers to make health plan decisions and reduce their out of pocket costs. HealthPocket also enhances our consolidated business operations by aggregating high-quality product sales referrals for STM and other health insurance products and ancillary products. We can monetize these referrals by selling them to third-party marketers of non-STM products and by turning STM referrals into sales of our STM products. In addition, the data aggregated by HealthPocket is used to research consumer needs and to measure product demand to help us design and manufacture high-demand insurance products.
The following table presents a reconciliation of premium equivalents to revenues for the years ended December 31, 2014 and 2013 ($ in thousands):
The following table presents the number of policies in force by product type as of December 31, 2014 and 2013:
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.
The following table presents a reconciliation of net income to EBITDA and adjusted EBITDA for the years ended December 31, 2014 and 2013 ($ in thousands):
The following table shows the financial results of our operating segments for the year ended December 31, 2014 ($ in thousands). For the year ended December 31, 2013, we operated as a single operating segment. The discussion of components of results of operations that follows the table is made at a consolidated level, with segment level discussions included where applicable. Because HP was acquired in the second half of 2014, there is no segment comparability with 2013.
Our revenues primarily consist of commissions and fees earned for health insurance policies and ancillary products 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. 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.
For insurance policies and ancillary products, we earn commissions for the policies issued, 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. 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.
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 plans in force. Revenues for 2014 were $88.8 million, an increase of $32.1 million, or 56.7%, compared to 2013. The increases were primarily due to the increase in the number of policies in force. The increase in policies in force was due primarily to the continuing expansion of our distribution network. In addition, the number of ancillary policies in force as of December 31, 2014 increased as we implemented a strategy to focus on including ancillary products to complement our core medical policy sales.
Revenues for the HP operating segment are $2.8 million. The revenues were primarily the result of referrals generated by HealthPocket.com which were sold to our referral partners.
Credit card and ACH fees for 2014 were $1.9 million, an increase of $690,000, or 58.8%, compared to 2013. The increase in credit card and ACH fees was primarily due to the increase in the number of plans in force.
Credit card and ACH fees represented 2.1% of revenues for 2014 and 2013.
Contract termination expense relates to a payment of $5.5 million to terminate certain contract rights with TSG, a managing general agent for the Company, during March 2013. This transaction was treated as an expense on the accompanying consolidated statement of operations for 2013. We did not experience any contract termination expense in 2014.
The increase in S, G & A expenses for the year ended December 31, 2014 was primarily attributable to a $6.9 million increase in operating expenses at Secured and SIL. The comparable period in 2013 included only the operations of Secured and SIL subsequent to Secured’s acquisition in July 2013 and SIL’s formation and commencement of operations in 2013. In addition, operating expenses at ICE increased $2.4 million due to increased payroll and investments for growth. Operating expenses also included $3.5 million of expenses at HP and ASIA; HP and ASIA were not owned by the Company during the year ended December 31, 2013. The increase in S, G & A also included $672,000 of increases in operating expenses, primarily investments for future growth. These expenses included marketing, selling and headquarters support including executive hires, payroll and certain non-recurring charges including executive severance.
Depreciation and amortization expenses for 2014 were $2.4 million, an increase of $1.1 million, compared to 2013. The increase in depreciation and amortization was primarily driven by amortization of intangible assets acquired in the Secured, HP and ASIA acquisitions.
Under GAAP, contingent consideration arrangements should be recorded at fair value for each period presented. The adjustments to the balances are recorded in the statement of operations. For the years ended December 31, 2014 and 2013, we recorded $1.1 million and $453,000 of expense related to changes in the fair value of the contingent consideration agreements. The fair value adjustments relate primarily to an increase in the probability of payment for the Secured contingent consideration and the discounting of the liabilities.
Other expense was $270,000 and $397,000 for the years ended December 31, 2014 and 2013, respectively. Other expense for 2014 included a charge of $500,000 for a cash deposit for a potential acquisition that we did not consummate, partially offset by $220,000 of fees charged to distributors for advanced commissions and a gain on the sale of an investment for $20,000. Other expense for 2013 included an expense payable to Mr. Kosloske under the tax receivable agreement for $423,000 and a loss on extinguishment of debt of $71,000, partially offset by $93,000 from fees charged to distributors for advance commissions.
We are the sole managing member of HPIH and have 100% of the voting rights and control. As of December 31, 2014, we had a 53.4% economic interest in HPIH, and HPI had a 46.6% economic interest in HPIH. HPI’s interest in HPIH is reflected as a noncontrolling interest on our accompanying consolidated financial statements contained elsewhere in this report.
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 8 of the accompanying consolidated financial statements for more information on this transaction and the Exchange Agreement.
As of December 31, 2014, we had $14.3 million of cash and cash equivalents, $7.6 million of cash held on behalf of others, and $461,000 of short-term investments. On July 14, 2014, we acquired HP for a cash payment of $21.9 million, plus 815,991 shares of our Class A common stock, net, with such shares of Class A common stock having an agreed upon aggregate value of $10.0 million, or $11.10 per share, which had a fair value of $6.7 million as of the acquisition date.
In September 2011, we entered into a bank loan agreement with a third-party bank with a principal amount of $4.3 million. On February 13, 2013, we repaid the remaining $3.2 million outstanding balance of the term loan, using a portion of the proceeds of the IPO.
The following summary of cash flows for the periods indicated has been derived from our financial statements included elsewhere in this report ($ in thousands):
The cash used in operating activities for 2013 was primarily attributable to the $5.5 million contract termination expense described above, an increase of $ 2.2 million in advanced commissions and increased S, G & A expenses, partially offset by an in increase in revenues.
In 2013 cash provided by financing activities was $50.1 million. 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.
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 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%. We have not drawn on the RLOC as of December 31, 2014.
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 September 30, 2014 and December 31, 2013 was $159,000 and $191,000, respectively.
Commission revenues earned at ICE, Secured, and ASIA, which are licensed insurance agent call centers are recognized as earned for sales of insurance and ancillary products. Commissions are earned based on commission rates contracted with insurance carriers or ancillary insurance product vendors, net of an estimate for forfeiture amounts payable for future policy cancellations.
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 on a straight-line basis 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.
Limited exclusivity fee revenue. HP offers to certain customers limited exclusivity for placement of advertisements on the HealthPocket website for a fee. This fee is recognized on a straight-line basis over the life of the limited exclusivity term.
Landing page development. HP offers to design, build and support a customer’s hosting of certain landing pages for the purpose of capturing e-leads and phone calls. Revenue for this service is recognized on a straight-line basis over the life of the support period of the landing pages.
Under FASB guidance, we have the option of performing a qualitative assessment to determine whether based on the fact and circumstances it is more likely than not that the fair value of the reporting unit exceeds the carrying value of its net assets. A qualitative assessment will require judgments involving relevant factors, including but not limited to, changes in the general economic environment, industry and regulatory considerations, current economic performance compared to historical economic performance and other relevant company-specific events such as changes in management, key personnel or business strategy, where applicable. If we elect to bypass the qualitative assessment, or if we determine, based upon our assessment of those qualitative factors that it is more likely than not that the fair value of the reporting unit is less than its carrying value, a quantitative assessment for impairment is required. We have two reporting units, which are our operating segments, IPD and HP.
The quantitative assessment for evaluating the potential impairment of goodwill involves a two-step assessment process which requires significant estimates and judgments by us to be used during the analysis. In step one we determine if there is an indication of goodwill impairment by determining the fair value of the reporting unit’s net assets and comparing that value to the reporting unit’s carrying value including the goodwill. If the carrying value of the net assets exceed the fair value, then the second step of the impairment assessment is required. The step two assessment determines if an impairment exists, and if so, the magnitude of the impairment by comparing the estimated fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. The excess of the carrying value over the estimated fair value of the goodwill determines the amount of impairment which would then be recorded as a loss on our statement of operations in the year the impairment occurred.
While performing a reporting unit’s impairment assessment we use a combination of valuation approaches including the market approach and the income approach.
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, 2014, we determined that the fair value of each reporting unit exceeded its respective carrying value. As such, a step two analysis was not required.
See Note 2 and Note 5 of the accompanying consolidated financial statements for further information on the acquisitions and our goodwill balance as of December 31, 2014 and 2013, respectively.
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.
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 S, G & A 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, 2014, would have affected net income by approximately $24,000.
We measure and report financial assets and liabilities at fair value on a recurring basis. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (referred to as an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value of our financial assets and liabilities is determined by using three levels of input, which are defined as follows: