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1. Organization
HealthExtras, Inc. (the "Company" or "HealthExtras") is a Delaware
corporation organized on July 9, 1999 and the successor to certain
predecessor companies (the "Predecessor Companies"). The Predecessor
Companies include: Sequel Newco, Inc., Sequel Newco Joint Venture
(the Joint Venture), Health Extras Partnership (HEP), Sequel Newco,
LLP (SN LLP) and HealthExtras LLC. Through December 31, 1998,
the Company was considered to be a development stage enterprise.
The Company commenced business operations with its health benefits
program on November 1, 1998; however, all operating revenues were
deferred and were recognized in 1999 in order to coincide with
the program member benefits.
Sequel Newco, Inc. (Sequel), an Iowa Corporation, was originally
incorporated on October 23, 1996 as PB Newco II, Inc. Sequel's
business, which consisted of developing and evaluating international
and domestic healthcare management service opportunities, was
contributed to the Joint Venture as of January 1, 1997. The Joint
Venture was originally formed on December 1, 1996 and its business
involved the development of provider software applications and
the development of international healthcare management opportunities.
Effective
April 7, 1997, the Joint Venture was merged into a limited liability
partnership, SN LLP. SN LLP continued the business of the Joint
Venture, i.e., the development of provider software applications
and the develop-ment of international healthcare management opportunities.
HEP
was originally formed on April 7, 1997 and its business involved
the development of supplemental catastrophic health benefit programs.
Effective August 1, 1998, SN LLP and HEP were merged into HealthExtras
LLC, a Maryland limited liability company, with HealthExtras,
LLC being the surviving business entity.
On
May 27, 1999, HealthExtras, LLC, which was then a Maryland limited
liability company, contributed substantially all of its assets
to HealthExtras, LLC, a Delaware limited liability company, and
Capital Z Healthcare Holding Corp. invested $5 million in that
entity in exchange for a 20% ownership interest.
On
December 17, 1999, in connection with the closing of the initial
public offering of 5,500,000 shares of the Company's common stock
at an initial public offering price of $11.00 per share, HealthExtras
LLC was merged into the Company with the Company being the surviving
entity (the "Reorganization") and the members of HealthExtras
LLC received an aggregate 22,100,000 shares of the Company's common
stock in exchange for their member interests. The net proceeds
received by the Company from the initial public offering (net
of underwriting commissions and expenses of $5.6 million) were
approximately $54.9 million.
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2. Summary of significant accounting policies
Basis
of presentation
The accompanying financial statements include the accounts of
the Company and the Predecessor Companies.
Cash
and cash equivalents
Cash
and cash equivalents consist of cash and investments in highly
liquid instruments with maturities of three months or less when
purchased.
Marketable securities
The Company has purchased certain marketable securities of a certain
related entity. Management considers all of the common stock purchased
to be available for sale as defined by SFAS No. 115, "Accounting
for Certain Investments in Debt and Equity Securities.'' Available
for sale securities are reported at fair value, with net unrealized
gains and losses reported as a component of other comprehensive
income. During 1997, the Company engaged in the trading of marketable
securities. Trading securities are reported at fair value, with
net unrealized gains and losses reported in the statement of operations
and comprehensive loss. Realized gains and losses on the sale
of trading securities are determined using the specific identification
method. For the year ended December 31, 1997, net realized gains
of $732,977 were recorded. All trading securities were sold prior
to December 31, 1997.
The historical cost, gross unrealized holding gains and fair value
of marketable securities available for sale as of December 31,
1998, and 1999 are as follows:
Fixed
assets
Fixed assets are stated at cost. Depreciation is computed
using the straight-line method over the estimated useful lives
of the assets, which range from three to seven years. Leasehold
improvements are amortized using the straight-line method over
the shorter of the estimated lives of the assets or the lease
term.
Concentration of credit risk
Financial instruments that potentially subject the Company to
significant concentrations of credit risk consist principally
of cash and cash equivalents. The Company maintains such amounts
in bank accounts which, at times, may exceed federally insured
amounts. The Company has not experienced any losses related to
its cash or cash equivalents and believes it is not exposed to
any significant credit risk on its cash or cash equivalents.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Contributions
Contributions made, including unconditional promises to give,
are recognized as expenses in the period made or promised.
Income taxes
Prior to the Reorganization, no provision for federal or state
income taxes was made in the accompanying financial statements
since the Company was treated as a partnership for federal and
state Income tax purposes.
Upon the Reorganization, the Company became subject to federal
and state income taxes. No provision for federal or state income
taxes has been made for the period from December 17, 1999 to December
31, 1999 as the Company incurred an operating loss for the period.
The Company records deferred tax assets and liabilities based
on temporary differences between the financial statement and the
tax bases of assets and liabilities using enacted tax rates in
effect in the year in which the differences are expected to reverse.
Net loss per share
Basic net loss per share is based on the weighted average
number of shares outstanding during the year. Diluted net loss
per share is based on the weighted average number of shares and
dilutive common stock equivalent shares outstanding during the
year. All outstanding stock options at December 31, 1999 were
excluded from the computation of diluted net loss per share because
the exercise price of the stock options exceeded the average market
price of the common shares, and therefore, were antidilutive.
Pro forma basic and diluted net loss per share and weighted average
shares outstanding reflect the formation of HealthExtras, Inc.
and merger with HealthExtras, LLC in exchange for Company common
stock as if the merger was effective January 1, 1997.
Pro forma basic net loss per share is computed based on the weighted
average number of outstanding shares of common stock. Pro forma
diluted net loss per share adjusts the pro forma basic shares
weighted average for the potential dilution that could occur if
stock options or warrants, if any, were exercised. Pro forma diluted
net loss per share is the same as pro forma basic net loss per
share because there were no dilutive securities outstanding at
December 31, 1997 and 1998.
Revenue and direct expense recognition
The primary determinant of revenue recognition is monthly program
enrollment. In general, revenue is recognized based on the number
of members enrolled in each reporting period multiplied by the
applicable monthly fee for their specific membership program.
The revenue recognized by HealthExtras includes the cost of membership
features supplied by others, including the insurance components.
Direct expenses consist of the costs that are a direct function
of a period of membership and a specific set of program features.
The coverage obligations of our benefit suppliers and the related
expense are determined monthly, as are the remaining direct expenses.
Revenue from program benefits and related direct expenses (principally
bank marketing and processing fees and the cost of the benefits
provided to program members) are initially deferred for 90 days,
the period during which a program member is generally entitled
to obtain a refund. If a member requests a refund, HealthExtras
retains any interest earned on funds held during the refunded
membership period. Revenue and direct expenses attributable to
the initial deferral are recognized in the subsequent month. After
the initial deferral period, revenue is recognized as earned and
direct expenses as incurred.
HealthExtras has historically maintained a prepaid balance for
the benefits included in its programs. The carrying value of the
prepayment is adjusted at the end of each quarter based on factors
including enrollment levels in each product, enrollment trends,
and the remaining portion of the unexpired prepayment period.
In the event that a period of coverage was purchased in advance,
and there were insufficient members to utilize the coverage, the
value would expire and be expensed by HealthExtras without any
related revenue. HealthExtras believes that current enrollment
levels will allow the balance at December 31, 1999 to be fully
utilized prior to expiration.
HealthExtras' members always enroll for an annual period but may
chose to pay either annually or in monthly installments. There
is no interest charged under the monthly option but members who
pay annually receive a reduced rate that reflects lower administrative,
transaction and maintenance costs.
Marketing agreements
The Company defers the amount of payments under marketing and
similar agreements. Expense is recognized straight-line over the
term of the agreements.
Segment reporting
The Company operates in only one market segment as a provider
of health and disability benefit programs to individuals. The
Company has no major customers and operates only in the United
States.
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3. Fixed assets
Fixed assets as of December 31, 1999 consist of the following:
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4. Income taxes
No provision for federal and state income taxes have been recorded
for the period from December 17, 1999 to December 31, 1999 as
the Company incurred an operating loss for the period. A summary
of the components of deferred income taxes at December 31, 1999
computed at an effective tax rate of 38.6% as follows:
The
Company has a net operating loss carryforward of approximately
$14,400 as of December 31, 1999. The effective tax rate for the
period from December 17, 1999 to December 31, 1999 varies from
the U.S. Federal Statutory tax rate principally due to the following:
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5.
Stockholders' equity
Stock
(member interests) grants
In
February 1999, certain management employees were granted effective
member interests aggregating 1.87% (equivalent to 413,333 common
shares, post Reorganization) of the Company, after giving effect
to an existing commitment to sell a 20% interest in the Company
to a third party for $5,000,000 cash. Such grants vest over a
four-year period commencing March 1, 1999. The Company recorded
the estimated fair value of such interests of $467,573 ($1.13
per post Reorganization common share) as stockholders' equity
and deferred compensation expense. During the year ended December
31, 1999, amortization of deferred compensation expensed amounted
to $97,341. The remainder of the deferred compensation expense
will be amortized over the vesting period for the interests.
Stock
option plan
In connection with the Reorganization and initial public offering,
the Company established the HealthExtras, Inc. 1999 Stock Option
Plan ("SOP"). The maximum number of shares of the Company's common
stock reserved for issuance pursuant to the exercise of options
under the SOP is 4,000,000 shares. All officers, employees and
independent contractors of the Company are eligible to receive
option awards. A Committee of the Board of Directors determines
award amounts, option prices and vesting periods, subject to the
provisions of the SOP.
Concurrent with the Reorganization and initial public offering,
stock options to purchase 2,956,000 shares of the Company's common
stock, all at an exercise price of $13.20 per share, were issued
to certain officers and employees of the Company. These stock
options vest ratably over a period of four years. None of the
stock options are exercisable and all remain outstanding as of
December 31, 1999. The contractual life of all of the stock options
is ten years.
During 1995, the Financial Accounting Standards Board issued Financial
Accounting Standard No. 123 ("FAS 123"), "Accounting for Stock-Based
Compensation." This pronouncement requires that the Company calculate
the fair value of stock options and shares issued under employee
stock purchase plans at the date of grant using an option-pricing
model. The Company has elected the "pro forma, disclosure only"
option permitted under FAS 123, instead of recording a charge
to operations. The following table reflects pro forma net loss
and net loss per share for the year ended December 31, 1999 had
the Company elected to adopt the fair value approach of FAS 123:
The
exercise price of each option granted in 1999 exceeded the market
price of the Company's common stock at the date of grant. The
grant date fair value of each option granted was $5.70 per share.
The estimated fair value of each option was calculated using the
modified American Black-Scholes economic option-pricing model.
The following table summarizes the weighted-average of the assumptions
used for stock options granted during 1999:
6. Bank line of credit
In
1998, the Company entered into a credit facility with a bank totaling
$2,000,000 and bearing interest at the prime rate (8.5% as of
December 31, 1999). The facility extends to February 2000, is
collateralized by substantially all the Company's assets and has
been guaranteed by United Payors & United Providers, Inc. As of
December 31, 1998, the Company had borrowed $1,750,000 under this
credit facility. As of December 31, 1999, all amounts due under
the credit facility have been paid. The Company terminated the
credit facility in January 2000.
Loan guarantee fees have been imputed based on the monthly amounts
outstanding under the credit line at an annual rate of 2%. The
imputed loan guarantee fees have been recorded as interest expense
in the statement of operations and as members' capital. Such fees
amounted to $0, and $45,453 for the years ended December 31, 1998,
and 1999, respectively.
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7.
Lease Commitments
The
Company has entered into an agreement dated December 22, 1999,
to lease office space under a non-cancelable sublease agreement
with United Payors & United Providers, Inc. The sublease agreement
provides for annual escalations and for the payment by the Company
of its proportionate share of the increase in the costs of operating
the building. For financial reporting purposes, the Company will
recognize rent expense on a straight-line basis over the term
of the sublease. Future minimum lease payments under the sublease
are as follows:
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8. Commitments
During
1997, the Company entered into two marketing agreements each with
an initial three-year term whereby the Company committed to make
$3,030,000 of non-refundable payments, payable in three equal
installments, to certain individuals in exchange for their participation
in various marketing campaigns. Under both marketing agreements,
the Company has the option to extend and renew the agreements
for an additional two-year period, which would result in additional
guaranteed minimum payments by the Company of approximately $2,034,000.
Under the marketing agreements, the Company must pay annual fees
of $1.00 and $0.10, respectively, per program member that subscribes
to the benefits promoted by the individuals when program members
exceed the number of program members covered under the guaranteed
payments referenced above. Such payments are for the initial three-year
term of the marketing agreements and shall continue for a 10-year
period thereafter.
Additionally, during 1997, the Company pledged to contribute $300,000
to a charitable foundation payable in equal installments of $100,000
commencing on August 1, 1997. The contribution commitment was
made to support education and research in the areas of paralysis
and related rehabilitation efforts. The contribution was made
independent of any direct or indirect obligation on the part of
the recipient to further HealthExtras' business or program marketing.
Through December 31, 1998, the Company paid $100,000 to the charitable
foundation. As of December 31, 1999, the entire pledge has been
satisfied.
During 1998, the Company entered into various agreements with
participating companies in the amount of $1,260,900, whereby the
Company committed to provide minimum enrollment in its programs.
The Company has historically maintained a prepaid expense balance
with respect to benefit features of its programs. Direct expense
is recognized based on the actual membership levels in each program.
The deferred amount at the end of each quarter is adjusted to
reflect advances, if any, made during the period, expenses recognized
and remaining coverage periods and membership levels to which
such advances can be applied. The Company has deferred expense
recognition for $879,300 and $731,786 in minimum and advance payments
at December 31, 1998 and 1999, respectively, with respect to these
commitments in order to match related future revenue recognition.
A liability of $546,562 for the unpaid amount included in accrued
benefit expense on the balance sheet as of December 31, 1998 was
paid during 1999.
During July 1998, the Company entered into an agreement for a
mass marketing campaign requiring a minimum payment of $100,000
which is included in sales and marketing expense for the year
ended December 31, 1998. A liability of $100,000 for such payment
included in accrued expenses on the balance sheet as of December
31, 1998 was paid during 1999.
The Company has entered into three-year employment agreements
with five of its executive officers. The annual base salaries
under these agreements range from $120,000 to $210,000, and one
executive will be entitled to a bonus equal to one percent of
the Company's annual after-tax profits. The Company's minimum
aggregate payments under these employment agreements are expected
to be $837,000 annually. In the ordinary course of business, the
Company may become subject to legal proceedings and claims. The
Company is not aware of any legal proceedings or claims which,
in the opinion of management, will have a material effect on the
financial condition or results of operations of the Company.
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9.
Related party transactions
For corporate business purposes, the Company utilizes the services
of an aircraft owned by Southern Aircraft Leasing, which is owned
by the Chairman of the Board of the Company. For the years ended
December 31, 1997, 1998 and 1999, the Company paid $105,703, $97,638,
and $156,185, respectively, for utilizing the services of the
aircraft.
The Company holds available for sale securities in a corporation
for which the Chairman of the Board of the Company is the Chairman
of the Board and Co-Chief Executive Officer. Investments held
were $1,144,255, and $664,984 as of December 31, 1998 and 1999,
respectively.
The Chairman of the Board of the Company, from time to time, loaned
the Company funds, in excess of his pro-rata share of capital
contributions, in order to underwrite operating expenses. This
loan amounted to $1,334,429 at December 31, 1998. Interest has
been imputed on the monthly outstanding balance of the loan at
an annual rate of 10%. The imputed interest has been recorded
as interest expense in the statement of operations and as stockholders'
equity. Imputed interest expense amounted to $476,346, $173,868,
and $150,109 for the years ended December 31, 1997, 1998, and
1999, respectively. All funds advanced have been repaid as of
December 31, 1999.
Effective January 1, 1999, the Company entered into an agreement
with United Payors & United Providers, Inc. ("UP&UP"), a corporation
for which the Chairman of the Board of the Company is Chairman
of the Board and Co-Chief Executive Officer, whereby UP&UP provides
administrative services for the Company and is reimbursed for
the costs incurred. Prior to January 1, 1999, the Company had
an unwritten arrangement with UP&UP to provide similar services.
The amount paid by the Company for such services were $76,661,
$866,385, and $3.3 million, for the years ended December 31, 1997,
1998 and 1999, respectively. Under a revised agreement dated December
22, 1999, services to be provided by UP&UP subsequent to March
31, 2000, will be limited primarily to services relating to information
technology and communications and will be paid on a cost plus
fee basis.
From time to time the Company owes UP&UP for the costs of administrative
services. Such amounts payable do not bear interest. Interest
on amounts due UP&UP has been imputed at an annual rate of 10%
and has been recorded as interest expense in the statement of
operations and as stockholders' equity. Such expense amounted
to $6,845, $64,611, and $72,501 for the years ended December 31,
1997, 1998 and 1999, respectively.
The Company also signed a five-year royalty agreement effective
January 1, 1999 relating to the Company's program members accessing
the UP&UP provider network. In return for providing network access
to UP&UP's national network of healthcare providers, the Company
will pay UP&UP $1.00 per member per month for the initial year
of membership, which amount escalates in stages for subsequent
membership years to a maximum of $1.50 per member per month in
the fourth year of continued membership and thereafter. However,
the Company can terminate these payments by conveying $25 million
in market value of the Company's common stock to UP&UP. Amounts
paid under this agreement in 1999 approximated $529,000.
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