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HIIQ > SEC Filings for HIIQ > Form 10-K on 25-Mar-2014All Recent SEC Filings

Show all filings for HEALTH INSURANCE INNOVATIONS, INC.

Form 10-K for HEALTH INSURANCE INNOVATIONS, INC.


25-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, 2013, and its financial condition as of December 31, 2013. 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.

Overview

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.

Our technology platform provides customers, who we refer to as members, immediate access to the products we sell through our distribution partners anytime, anyplace. The health insurance products we develop are underwritten by insurance carriers, and we assume no underwriting, insurance or reimbursement risk. Members can price and 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 all 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 significant operating leverage as we add members and reduces the costs associated with marketing, selling, underwriting and administering policies.

We are an industry leader in the sale of up to six, 11 and approximately 12-month (i.e., up to 364 day) STM plans, an alternative to PPACA-qualified IMM plans, which provide lifetime renewable coverage. STM plans generally offer qualifying individuals comparable benefits for fixed short-term durations of six, 11 or 12 months generally at lower premiums than IMM plans. STM plans feature a streamlined underwriting process offering immediate coverage options. We also offer guaranteed-issue 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 and cancer/critical illness plans that are frequently purchased as supplements to STM and hospital indemnity plans. We design and structure insurance products on behalf of insurance carriers, market them to individuals through our internal distribution capacity, which was expanded through the July 2013 acquisition of Secured, formerly one of our independent distributors, and through our large network of distributors and 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. We have established relationships


with several highly rated insurance carriers, including, Starr Indemnity & Liability Company, HCC Life, United States Fire, ING, Nationwide and CIGNA, among others. In addition, as of December 31, 2013, the large independent distribution network we access consists of 93 licensed agent call centers and 232 wholesalers, including Marsh and eHealth, among others, that work with over 10,000 licensed brokers. Our data-driven product design, technology platform and extensive distribution network have enabled us to grow our revenues from $41.9 million in 2012 to $56.6 million in 2013.

We focus on the large and under-penetrated segment of the U.S. population who are uninsured or underinsured, which includes individuals not covered by employer-sponsored insurance plans, such as the self-employed as well as small business owners and their employees, individuals who are unable to afford IMM premiums, and underserved "gap populations" that require insurance due to changes caused by life events: new graduates, divorcees, early retirees, military discharges, the unemployed, part-time and seasonal employees and temporary workers and customers seeking health insurance between the open enrollment periods held each year by the Exchanges. According to U.S. Census Bureau estimates, approximately 48 million Americans were uninsured in 2012.

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, 2013, we had 28,709 STM plans in force, compared with 23,747 on December 31, 2012. 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, 2013, our premium equivalents and revenues were $100.0 million and $56.6 million, respectively, representing increases of 31.8% and 35.0%, compared to the year ended December 31, 2012. 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.

Effects of the IPO and Related Transactions on our Corporate Structure

Historically, our business was operated through HPI. In anticipation of the IPO, on November 7, 2012, HPI assigned the operating assets of our business through a series of transactions to HPIH, and HPIH assumed the operating liabilities of HPI. Since November 2012, all of our business is conducted through HPIH.

HII was formed for the purpose of our recently completed IPO, and is a holding company whose principal asset is its interest in HPIH. All of the equity of HPIH outstanding prior to the reorganization has been exchanged for Series B Membership Interests of HPIH and an equal number of shares of our Class B common stock, and these Membership Interests and shares are held by HPI and a related entity and are beneficially owned by Michael Kosloske, our Chairman, President and Chief Executive Officer. Our financial statements consolidate the financial results of HPIH from February 13, 2013, the date of the IPO, and reflect solely the consolidated financial results of HPIH and HPI from November 7, 2012 to February 12, 2013 and solely the financial results of HPI and its subsidiaries prior to that date.


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 prior acquisition of Series B membership interests with net proceeds of the sale of over-allotment shares as part of the IPO, will result in increases in the tax basis in our share of the tangible and intangible assets of HPIH. We expect that these increases in tax basis, which would not have been available but for the HII 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, 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, HPI, is taxed as an S corporation for income tax purposes. Therefore, we were not subject to entity-level federal or state income taxation while operating as that entity. HPIH is currently taxed as a partnership for federal income tax purposes; and as a result, is also not subject to entity-level federal or state income taxation while the members of HPIH pay taxes with respect to their allocable shares of its net taxable income. The earnings of HII are subject to federal income taxation.

Key Business Metrics

In addition to traditional financial metrics, we rely upon the following key business metrics to evaluate our business performance and facilitate long-term strategic planning:

Premium equivalents. We define this metric as the combination of premiums, fees for discount benefit plans, and 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, 2013 and 2012 ($ in thousands):

                                                           December 31,
                                                        2013          2012
        Premium equivalents                           $ 100,002     $  75,872
        Less risk premium                               (40,922 )     (32,346 )
        Less amounts earned by third party obligors      (2,441 )      (1,586 )
        Revenues                                      $  56,639     $  41,940

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 plans, up to 11 months for our 11 months plans, up to 12 months for our approximately 12-month (i.e., up to 364 days) STM plans and often more than 12 months for our hospital indemnity and discount benefit plans, provided that the policy or discount benefit plan is not cancelled. A member may be enrolled in more than one policy or discount benefit plan simultaneously. A plan becomes inactive upon notification to us of termination of the policy or discount benefit plan, when the member's policy or discount benefit plan expires or following non-payment of premiums or discount benefit fees when due.

The following table presents the number of policies in force by product type as of December 31, 2013 and 2012:

                                         December 31,
                                       2013         2012       Change (%)
                STM                    28,709       23,747            20.9 %
                Hospital indemnity      8,366        8,141             2.8 %
                Ancillary products     36,611       26,230            39.6 %
                Total                  73,686       58,118            26.8 %


Non GAAP gross margin. We define non GAAP gross margin as revenue less third party commissions and credit card and ACH fees. Non GAAP gross margin does not represent, and should not be considered as, an alternative to revenues, as determined in accordance with U.S. GAAP. Non GAAP 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, non GAAP gross margin can provide a useful measure for period-to-period comparisons of our business. Non GAAP 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 U.S. GAAP.

The following table presents a reconciliation of premium equivalents and revenues to non GAAP gross margin ($ in thousands):

                                                           December 31,
                                                        2013          2012
        Premium equivalents                           $ 100,002     $  75,872
        Less risk premium                               (40,922 )     (32,346 )
        Less amounts earned by third party obligors      (2,441 )      (1,586 )
        Revenues                                         56,639        41,940
        Less third-party commissions                    (32,244 )     (27,858 )
        Less credit card and ACH fees                    (1,173 )        (963 )
        Non GAAP gross margin                         $  23,222     $  13,119

EBITDA and Adjusted EBITDA. We define this metric as net (loss) income before interest expense, income taxes and depreciation and amortization. We have included EBITDA in this report because it is a key measure used by our management and board of directors 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 exclusion of certain expenses in calculating EBITDA can provide a useful measure for period-to-period comparisons of our business. However, 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. Other companies may calculate EBITDA differently than we do. 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.

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, 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 U.S. generally accepted accounting principles, or U.S. 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 U.S. GAAP.

The following table presents a reconciliation of net income to EBITDA and adjusted EBITDA for the years ended December 31, 2013 and 2012 ($ in thousands):

                                                       December 31,
                                                     2013        2012
               Net income (loss) (1)               $ (8,419 )   $ 3,260
               Interest expense                           1         271
               Depreciation and amortization          1,313       1,012
               Provision for income taxes                18           -
               EBITDA                                (7,087 )     4,543
               Non-cash stock based compensation      6,296           -
               Contract termination expense           5,500           -
               Acquisition costs                        301           -
               Adjusted EBITDA                     $  5,010     $ 4,543

(1) Net loss for the year ended December 31, 2013 includes a one-time expense of $5.5 million related to the termination of contact rights with TSG Agency, LLC ("TSG"), a managing general agent of the Company. For further information, see "Comparison of 2013 and 2012" below.


Key Components of Our Statements of Operations

Revenues

Our revenues consist primarily of commissions earned for our 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. We recognize revenues upon the member's acceptance of a policy. 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. 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.

Commission rates for all insurance plans are approved in advance by the relevant insurance carrier. Our commission rates and the length of the commission period typically vary by carrier and plan type. Under our carrier compensation arrangements, the commission rate schedule that is in effect on the policy effective date will govern the commissions over the life of the plan.

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.

Operating Expenses

Operating expenses consist of fees and commissions paid to distributors for selling our products to members, credit card or ACH processing fees, selling, general and administrative expenses, contract termination expense and depreciation and amortization.

Third-party Commissions

Our third-party commissions consist of fees and commissions paid to distributors for selling our products to members, which we pay monthly for existing members and on a weekly basis for new members. As noted above, in July 2013, we acquired Secured, a significant distributor, and third-party commissions decreased as a percentage of revenues during the remainder of 2013. Third-party commissions in 2013 were also reduced by the termination of our contract with TSG, a managing general agent.

Credit Card and ACH Fees

Our credit card and ACH fees are fees paid to our banks and processors for the collection of credit card and ACH payments. We expect credit card and ACH fees as a percentage of revenue in future periods to remain generally consistent with prior periods.

Selling, General and Administrative Expenses

Our general and administrative expenses primarily consist of personnel costs, which represent salaries, bonuses, commissions, payroll taxes and benefits. Selling, 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. Selling, general and administrative expenses increased in 2013 in part due to equity-based compensation under our long-term incentive plan. Expense for equity-based compensation to existing employees is expected to be lower in 2014 than in 2013. However, future increases associated with our business growth initiatives, including our enhanced marketing and leads generation plans, are expected.

Depreciation and Amortization

Depreciation and amortization expense is primarily a function of amortization of intangible assets acquired as a result of our acquisitions as well as depreciation of property and equipment used in our business.

Interest Expense

Interest expense primarily consists of interest incurred on our outstanding bank note that was repaid in February 2013 with a portion of the net proceeds raised from the IPO and interest expense on a long-term noncompete agreement. Interest expense is partially offset by interest income earned on cash equivalents and investments.

Other Expense (Income)

Other expense (income) includes expenses payable to Mr. Kosloske pursuant to the tax receivable agreement as described above and fees charged to distributors for advanced commissions, whereby we pay distributors commissions on policies sold in advance of


when they would ordinarily be due to the distributor. These advanced commissions are made to distributors with an established track record of selling our products. Advanced commission fees range from 0% up to 2% of the premiums for each month that we advance commissions. Advanced commissions to a distributor are based upon the number of future months of expected premium equivalent multiplied by a distributor's commission rate. We expect other income to increase as we expand our advanced commission structure.

Provision for income taxes

Our former operating entity, HPI, is taxed as an S corporation for income tax purposes. Therefore, we were not subject to entity-level federal or state income taxation prior to the IPO. HPIH is currently taxed as a partnership for federal income tax purposes; and as a result, the members pay taxes with respect to their allocable shares of HPIH's respective net taxable income.

Following the IPO, HPIH continues to operate in the United States a partnership for U.S. federal income tax purposes. The portion of HPIH earnings that are allocated to HII are subject to U.S. corporate federal, state and local income taxes that are reflected in our consolidated financial statements.

Our effective tax rate includes a rate reduction attributable to the fact that our subsidiaries operate as limited liability companies which are not subject to federal or state income tax. Accordingly, a portion of our earnings or losses attributable to the noncontrolling interest are not subject to corporate level taxes. Additionally, our effective tax rate includes a valuation allowance placed on all of our deferred tax assets, as we believe it is more likely than not that our deferred tax assets will not be realized to offset future taxable income.

We account for uncertainty in income taxes using a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon audit, including resolution of related appeals or litigation processes, if any. The second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. Such amounts are subjective, as a determination must be made on the probability of various possible outcomes. We reevaluate uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition and measurement could result in recognition of a tax benefit or an additional tax provision.

As of December 31, 2013 and 2012, we did not have any balance of gross unrecognized tax benefits associated with uncertain tax positions, and as such, no amount would favorably affect the effective income tax rate in any future periods. We believe that there will not be a significant increase or decrease to the uncertain tax positions within 12 months of the reporting date.

We have federal net operating loss carryforwards of approximately $338,000, and varying amounts of state net operating loss carryforwards. These carryforwards remain available for utilization through the 2033 tax year.

Noncontrolling Interest

Upon completion of the IPO, HII became a holding company, the principal asset of which is its interest in HPIH. All of our business is conducted through HPIH and its subsidiaries. We are the sole managing member of HPIH and have 100% of the voting rights and control. As of December 31, 2013, we have a 37.7% economic interest in HPIH, and HPI possesses 62.3% economic interest in HPIH. HPI's interest in HPIH is reflected as a noncontrolling interest in our accompanying consolidated financial statements.

On June 1, 2012, we and TSG acquired ICE. ICE conducts call center operations and is a 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 center managers and educate them on our model and best practices with the ultimate goal of these call centers joining our distribution network. During the year ended December 31, 2013, we contributed $40,000, and TSG contributed $16,000 to ICE. On June 30, 2013, we acquired TSG's interest in ICE for $90,000, and ICE became a wholly-owned subsidiary.


Results of Operations

Comparison of 2013 and 2012

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