We are a leading developer and administrator of affordable, web-based individual health insurance plans and ancillary products. Our highly scalable, proprietary, web-based technology platform allows for mass distribution of and online enrollment in our large and diverse portfolio of affordable health insurance offerings.
On September 28, 2011, we entered into an agreement to purchase of the units of Health Plan Intermediaries, LLC owned by Naylor Group Partners, LLC. Prior to the purchase (the “Acquisition”), Health Plan Intermediaries, LLC was 50% owned by Naylor Group Partners, LLC and 50% owned by Mr. Kosloske. Following the Acquisition, Mr. Kosloske became the sole member of Health Plan Intermediaries, LLC. The Acquisition was accounted for as a purchase and the purchase price was reflected on our financial statements using push-down accounting. Accordingly, purchase accounting adjustments have been reflected in our financial statements for the period commencing on October 1, 2011. The new basis of accounting reflects the estimated fair value of the our assets and liabilities as of the date of the Acquisition. We used October 1, 2011, as the effective date of the transaction, since the operating activity between that date and the September 28, 2011 transaction date was not material.
Historically, our business was operated through Health Plan Intermediaries, LLC. In anticipation of the IPO, on November 7, 2012, Health Plan Intermediaries, LLC assigned the operating assets of our business through a series of transactions to Health Plan Intermediaries Holdings, LLC, and Health Plan Intermediaries Holdings, LLC assumed the operating liabilities of Health Plan Intermediaries, LLC.
Health Insurance Innovations, Inc. was formed for the purpose of our recently completed IPO. Since November 2012, all of our business is conducted through Health Plan Intermediaries Holdings, LLC. The financial results of Health Plan Intermediaries Holdings, LLC will be consolidated in our financial statements.
Health Insurance Innovations, Inc. is a holding company whose principal asset is its interest in Health Plan Intermediaries Holdings, LLC. All of the equity of Health Plan Intermediaries Holdings, LLC outstanding prior to the reorganization has been exchanged for Series B Membership Interests of Health Plan Intermediaries Holdings, LLC and an equal number of shares of our Class B common stock.
We expect that future exchanges of Series B Membership Interests (together with an equal number of our Class B common shares) for shares of our Class A common stock, as well as the Acquisition with net proceeds of the sale of over-allotment shares, of Series B Membership Interests (together with an equal number of shares of our Class B common stock) from Health Plan Intermediaries, LLC (which Series B Membership Interests will immediately be recapitalized into Series A Membership Interests) will result in increases in the tax basis in our share of the tangible and intangible assets of Health Plan Intermediaries Holdings, LLC. We expect that these increases in tax basis, which would not have been available but for our new holding company structure, will reduce the amount of tax that we would otherwise be required to pay in the future. We will be required to pay a portion of the cash savings we actually realize from such increase (or are deemed to realize in the case of an early termination payment by us, a change in control or a material breach by us of our obligations under the tax receivable agreement, as discussed above) to the existing and certain future holders of Series B Membership Interests (currently Health Plan Intermediaries, LLC and Health Plan Intermediaries Sub, LLC, which are beneficially owned by Mr. Kosloske), pursuant to a tax receivable agreement. Furthermore, payments under the tax receivable agreement will give rise to additional tax benefits and therefore additional payments under the tax receivable agreement itself. Our
former operating entity, Health Plan Intermediaries, LLC, is taxed as an S corporation for income tax purposes. Therefore, we have not been subject to entity-level federal or state income taxation. Health Plan Intermediaries Holdings, LLC is currently taxed as a partnership for federal income tax purposes; and as a result, the members of Health Plan Intermediaries Holdings, LLC pay taxes with respect to their allocable shares of its net taxable income. The earnings of Health Insurance Innovations, Inc. are subject to federal income taxation.
Commission revenue and fees attributable to revenues from STM plans and hospital indemnity policies represented substantially all of our revenues for the periods presented. Our commissions 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 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.
We pay fees to distributors for their services in selling our plans, which are included in our operating costs and expenses.
Premium equivalents. We define this metric as the combination of premiums, fees for discount benefit plans, fees for distributors and our enrollment fees. All amounts not paid out as risk premium to carriers or paid out to other third-party obligors are considered to be revenues for financial reporting purposes. We have included premium equivalents in this report because it is a key measure used by our management to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget and to develop short- and long-term operational plans. In particular, the inclusion of premium equivalents can provide a useful measure for period-to-period comparisons of our business.
The following table presents a reconciliation of premium equivalents to revenues for the years ended December 31, 2012 and 2011:
Plans in force. We consider a plan to be in force when we have issued a member his or her insurance policy or discount benefit plan and have collected the applicable premium payments and/or discount benefit fees. Our plans in force are an important indicator of our expected revenues, as we receive a monthly commission for up to six months for our six-month STM plan, up to 12 months for
Our general and administrative expenses primarily consist of personnel costs, which represent salaries, bonuses, commissions, payroll taxes and benefits. General and administrative expenses also include marketing campaign expenditures and travel costs associated with obtaining new distributor relationships. In addition, these expenses also include technology expenses and personnel costs and expenses for outside professional services, including legal, audit and financial services. We expect general and administrative expenses to increase due to the anticipated growth of our business and infrastructure and the costs associated with becoming a public company, such as costs associated with SEC reporting and compliance, developing and maintaining internal controls over financial reporting, insurance, investor relations and other related costs. We also expect general and administrative expenses to increase as a result of equity-based compensation under our long-term incentive plan.
Our former operating entity, Health Plan Intermediaries, LLC, is taxed as an S corporation for income tax purposes. Therefore, we have not been subject to entity-level federal or state income taxation. Health Plan Intermediaries Holdings, LLC is currently taxed as a partnership for federal income tax purposes; and as a result, the members of Health Plan Intermediaries Holdings, LLC pay taxes with respect to their allocable shares of its net taxable income. The earnings of Health Insurance Innovations, Inc. are subject to federal income taxation. Health Insurance Innovations, Inc. accounts for income taxes in accordance under the provisions GAAP. Based on this guidance, our historical statements of operations would have reflected total income tax expense in the amount of approximately $1,250,000 and $896,000 for the years ended December 31, 2012 and 2011, respectively.
On June 1, 2012, we and TSG acquired ICE. ICE is a call center training facility for our distributors. Pursuant to the terms of the transaction, we contributed $80,000 in cash, and TSG contributed $20,000 in cash to the newly created limited liability company. In connection with the transaction, we received an 80% controlling interest in ICE and TSG received a 20% noncontrolling interest in ICE. The intent of this transaction was to attract potential call centers and educate them on our model and best practices with the ultimate goal of these call centers joining our distribution network. Subsequent to the initial contributions, we contributed an additional $240,000, and TSG contributed an additional $60,000, respectively, to ICE during the year ended December 31, 2012. As of December 31, 2012, our total investment in ICE is $320,000, representing an 80% controlling interest.
The following table is a summary of our statements of operations as a percentage of our total revenues.
The following table presents our historical results of operations and the changes in these results in dollars and as a percentage for the years presented:
Third-party commissions for 2012 were $27,858,000, an increase of $6,154,000, or 28.4%, compared to 2011. The increase in third-party commissions was primarily due to an increase in the number of plans in force. Third-party commissions represented 66.4% of revenues for 2012 as compared to 72.6% of revenues for 2011. This decrease is primarily due to a shift in our core business from hospital indemnity policies to STM policies. Generally, STM policies incur lower commissions than hospital indemnity policies.
Credit card and ACH fees for 2012 were $963,000, an increase of $293,000, or 43.7%, compared to 2011. 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 2.3% and 2.2% of revenues for 2012 and 2011, respectively.
General and administrative expenses for 2012 were $8,611,000, an increase of $3,849,000, or 80.8%, compared to 2011. The increase in general and administrative expenses was driven by an increase in personnel costs of approximately $1,761,000, professional fees of approximately $1,273,000 and selling, marketing expenses and other expenses of approximately $848,000. Personnel costs increased primarily due to additional sales and financial reporting personnel added to accommodate our growth. Professional fees increased as a result of legal fees, accounting and financial consulting costs and for the maintenance of our administrative technology platform. The increase in selling and marketing expenses was primarily due to our adoption of a revised sales strategy and the hiring of additional sales employees to implement the strategy.
Depreciation and amortization expenses for 2012 were $1,012,000, an increase of $714,000, compared to 2011. The increase in depreciation and amortization from was primarily driven by the amortization of intangible assets that were recognized from the Acquisition and the acquisition of intellectual property rights during 2012. For further information related to the Acquisition, see Note 2 in the accompanying audited financial statements.
Interest expense for 2012 was $271,000, an increase of $200,000, compared to 2011. Interest expense increased due to the bank loan agreement that commenced during the third quarter of 2011 to finance the Acquisition.
Other income for 2012 was $35,000, as compared to no other income during 2011. Other income primarily included fees charged to distributors for advanced commissions. We began to distribute advanced commissions during the fourth quarter of 2011.
During the year ended December 31, 2012, Health Plan Intermediaries, LLC declared cash distributions of $4,010,000 to Mr. Kosloske in accordance with the terms of its Operating Agreement. Of this 2012 declared distribution, $773,000 is payable as of December 31, 2012. Such payments made to members in 2011 totaled $1,301,000 ($681,000 was paid to Naylor Group Partners, LLC and $620,000 was paid to Mr. Kosloske). Mr. Kosloske contributed capital in the amount of $1,135,000 during the year ended December 31, 2011 to partially fund the Acquisition.
On February 13, 2013, Health Insurance Innovations, Inc. completed an initial public offering by issuing 4,666,667 shares of its Class A common stock, par value $0.001 to the public at a price of $14.00 per share common stock. In conjunction with the offering, Health Plan Innovations, Inc. obtained a 35% membership interest, a 35% economic interest and 100% of the voting interest in Health Plan Intermediaries Holdings, LLC.
As of December 31, 2012, the outstanding balance of the term loan was $3,294,000, including a current portion of $813,000. On February 13, 2013, we paid $3,232,000 to repay all of the outstanding debt under our term loan, using a portion of the net proceeds from the IPO.
We experienced positive cash flows from operating activities during 2012 and 2011 primarily as a result of our increased revenues and the resulting net income during these periods. Our primary source of cash from operating activities is retention of commissions from premium equivalents. Our primary uses of cash for operating activities are for compensation-related expenditures, settlement of accounts payable to vendors and to fund our advanced commission structure.
Our primary investing activities have consisted of the Acquisition, purchases of equipment and loans to our distributors. Our capital expenditures primarily consist of purchases of computer equipment, furniture and fixtures and computer software. In the future, we expect that we will continue to incur capital expenditures to support our expanding operations.
The following unaudited pro forma consolidated statements of operations for the years ended December 31, 2012 and 2011 and the unaudited pro forma consolidated balance sheet as of December 31, 2012 present our consolidated results of operations and financial position to give pro forma effect to the purchase of the units of Health Plan Intermediaries, LLC owned by Naylor Group Partners, LLC described under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the reorganization transactions described in “Item 1. Business-Our History and the Reorganization of Our Corporate Structure” and the sale of shares in the IPO (excluding shares issuable upon any exercise of the underwriters’ over-allotment option) and the application of the net proceeds
the reorganization transactions described in “Item 1. Business-Our History and the Reorganization of Our Corporate Structure,” including (i) the issuance by Health Plan Intermediaries Holdings, LLC of Series A membership interests to Health Insurance Innovations, Inc. pursuant to the Third Amended and Restated Limited Liability Company Agreement of Health Plan Intermediaries Holdings, LLC, (ii) the consolidation of Health Plan Intermediaries Holdings, LLC and its consolidated subsidiaries into Health Insurance Innovations, Inc.’s financial statements pursuant to FASB guidance and the resulting increase of additional paid-in-capital to allocate a portion of Health Plan Intermediaries Holdings, LLC’s equity to the noncontrolling interest, (iii) the conversion of each share of Health Insurance Innovations, Inc.’s outstanding common stock into 86,667.67 shares of Class B common stock pursuant to Health Insurance Innovations, Inc.’s Amended and Restated Certificate of Incorporation and (iv) the issuance of shares of Class A common stock of Health Insurance Innovations, Inc. in connection with the IPO;
the application of a portion of the proceeds from the IPO to repay outstanding indebtedness, as described in “Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities-Use of Proceeds.”
The IPO and the reorganization transactions did not result in an immediate step-up in the tax basis in our share of the tangible and intangible assets of Health Plan Intermediaries Holdings, LLC. However, future purchases or exchanges of 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 are expected to increase the tax basis in our share of the tangible and intangible assets of Health Plan Intermediaries Holdings, LLC. The step-up in tax basis would be initially depreciable and amortizable for tax purposes over a period of approximately 15 years. We entered into a tax receivable agreement with the holders of Series B Membership Interests after giving effect to the reorganization and certain future holders of Series B Membership Interests that will require us to pay such holders 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize (or are deemed to realize in the case of an early termination payment, a change in control or a material breach by us of our obligations under the tax receivable agreement) as a result of the increases in tax basis and of certain other tax benefits related to entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement. Assuming all Series B Membership Interests of Health Plan Intermediaries Holdings, LLC beneficially owned by Mr. Kosloske were acquired by us in a taxable transaction as of the date of the IPO, the step-up in the tax basis in our share of the tangible and intangible assets and the resulting estimated maximum payment due under the tax receivable agreement would be $162,348,000 and $53,001,000, respectively, based on our estimate of the tax basis in Health Plan Intermediaries Holdings, LLC’s assets as of December 31, 2012. We are not currently a party to any other agreements or commitments for any such acquisitions, and we have no current understandings with respect to any other such transactions. The actual amount of the tax receivable payment may materially differ from this hypothetical amount, as potential future payments will be calculated using the market value of our Class A common stock at the time of relevant exchange and prevailing tax rates in future years and will be dependent on us generating sufficient future taxable income to realize the benefit. Payments are generally due under the tax receivable agreement within a specified period of time following the filing of our tax return for the taxable year with respect to which the payment obligation arises, although interest on such payments will begin to accrue at a rate of LIBOR from the due date (without extensions) of such tax return. Late payments generally accrue interest at a rate of LIBOR plus 300 basis points. However, to the extent, based on certain specified reasons, that we do not have available cash to satisfy our payment obligations under the tax receivable agreement, such deferred payments would accrue interest at a rate of LIBOR.
On March 14, 2013, we entered into an agreement to terminate certain contract rights with TSG, a managing general agent of the Company, for an aggregate cash price of $5,500,000.
(2) As a newly formed entity, Health Insurance Innovations, Inc. had no assets or results of operations until the completion of the IPO.
(4) On September 28, 2011, we entered into an agreement to purchase the units of Health Plan Intermediaries, LLC owned by Naylor Group Partners, LLC for $5,330,000 plus closing costs of $135,000. Prior to this purchase, Health Plan Intermediaries, LLC was 50% owned by Naylor Group Partners, LLC and 50% owned by our Chairman, President and Chief Executive Officer, Mr. Kosloske. Following the purchase, Mr. Kosloske became the sole member of Health Plan Intermediaries, LLC. Adjustments represent the amortization of the intangible assets that resulted from the acquisition and the interest expense related to the bank loan agreement with SunTrust Bank for the purpose of financing the acquisition.
(6) Health Plan Intermediaries Holdings, LLC is not currently subject to entity-level federal income taxation and taxes with respect to income of Health Plan Intermediaries Holdings, LLC are payable by Health Plan Intermediaries Holdings, LLC’s equity holders at rates applicable to them. Following the IPO, and the reorganization that we are undertaking in connection therewith, earnings recorded by us will be subject to federal income taxation.
(7) Following the IPO, Health Insurance Innovations, Inc. will be subject to U.S. federal income taxes, in addition to state and local taxes, with respect to its allocable share of any taxable income of Health Plan Intermediaries Holdings, LLC. As a result, the pro forma consolidated statement of operations reflects an adjustment to our provision for corporate income taxes to reflect an effective rate of 38%, which includes provision for U.S. federal income taxes.
Under the FASB guidance, the process of evaluating the potential impairment of goodwill involves a two-step process and requires significant judgment at many points during the analysis. In the first step, we determine whether there is an indication of impairment by comparing the fair value of the reporting unit to its carrying amount, including goodwill. Our annual impairment test is performed with a measurement date of October 1. If, based on the first step, we determine that there is an indication of goodwill impairment, we assess the impairment in step two in accordance with the FASB guidance.
The income approach uses a discounted debt-free cash flow analysis to measure fair value by estimating the present value of future economic benefits. To perform the discounted debt-free cash flow analysis, we develop a pro forma analysis of the reporting unit to estimate future available debt-free cash flow and discounting estimated debt-free cash flow by an estimated industry weighted average cost of capital based on the same comparable companies used in the market approach. Per the FASB guidance, the weighted average cost of capital is based on inputs (e.g., capital structure, risk, etc.) from a market participant’s perspective and not necessarily from the reporting unit’s perspective. Future cash flow is projected based on assumptions for our economic growth, industry expansion, future operations and the discount rate, all of which require significant judgments by management.
Advanced commissions consist of amounts advanced to certain third-party distributors. We began advancing commissions in November 2011. We perform ongoing credit evaluations of our distributors, all of which are located in the United States. We recover the advanced commissions from future commissions earned on premiums collected. We have not experienced any credit losses from commission advances and accordingly, have not recognized any provision for bad debt expense at December 31, 2012. A fee for the advanced commission of up to 2% of the insurance premiums advanced is charged to the distributors and recognized as other income as earned. Advanced commissions outstanding at December 31, 2012 and December 31, 2011 totaled approximately $297,000 and $24,000, respectively.
In December 2011, the FASB issued guidance which requires disclosures of both gross and net information about instrument and transactions eligible for offset as well as transactions subject to an agreement similar to a master netting agreement. This guidance is effective for annual periods beginning on or after January 1, 2013 and interim periods within those annual periods and must be applied retrospectively. As this guidance is limited to presentation only, adoption of this guidance is not expected to have a material impact on our financial position or results of operations.