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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
COMMISSION FILE NUMBER 1-15535
HEALTHEXTRAS, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-2181356
--------- -----------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
2275 Research Boulevard, 7th Floor, Rockville, Maryland 20850 (Address
of principal executive offices, zip code)
(301) 548-2900
(Registrant's phone number, including area code)
Not Applicable
-----------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Securities registered pursuant to 12(b) of the Act: None
Securities registered pursuant to 12(g) of the Act: Common Stock,
$0.01 par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: ( X )
The number of shares of Common Stock, par value $.01 per share, outstanding on
March 21, 2000 was 27,600,000. As of March 21, 2000, assuming as fair value the
last sale price of $5.25 per share on The Nasdaq Stock Market, the aggregate
fair value of shares held by non-affiliates was approximately $28,875,000.
Documents incorporated by reference:
The Company's Proxy Statement for its annual meeting of stockholders to be held
in June, 2000, a definitive copy of which will be filed within 120 days of
December 31, 1999, is incorporated by reference in Part III of this Report on
Form 10-K.
TABLE OF CONTENTS
Page
PART I
Item 1. Business.......................................... 3
Item 2. Properties........................................ 11
Item 3. Legal Proceedings................................. 11
Item 4. Submission of Matters for a Vote of Security
Holders........................................... 11
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................ 12
Item 6. Selected Financial Data........................... 13
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............... 14
Item 7A Quantitative and Qualitative Disclosures About Market
Risk.............................................. 21
Item 8. Financial Statements and Supplementary Data....... 21
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............... 21
PART III
Item 10. Directors and Executive Officers of the Registrant 22
Item 11. Executive Compensation............................ 22
Item 12. Security Ownership of Certain Beneficial Owners
and Management.................................... 22
Item 13. Certain Relationships and Related Transactions.... 22
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.............................. 23
SIGNATURES
THIS FORM 10-K, INCLUDING THE DOCUMENTS INCORPORATED BY REFERENCE, CONTAINS
CERTAIN FORWARD-LOOKING STATEMENTS, INCLUDING WITHOUT LIMITATION, STATEMENTS
CONCERNING THE COMPANY'S OPERATIONS, ECONOMIC PERFORMANCE AND FINANCIAL
CONDITION. THESE FORWARD-LOOKING STATEMENTS ARE MADE PURSUANT TO THE SAFE HARBOR
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE WORDS
"BELIEVE," "EXPECT," "ANTICIPATE" AND OTHER SIMILAR EXPRESSIONS GENERALLY
IDENTIFY FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED NOT TO PLACE UNDUE
RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THEIR
DATES. THESE FORWARD-LOOKING STATEMENTS ARE BASED LARGELY ON THE COMPANY'S
CURRENT EXPECTATIONS AND ARE SUBJECT TO A NUMBER OF RISKS AND UNCERTAINTIES,
INCLUDING, WITHOUT LIMITATION, THOSE IDENTIFIED UNDER "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND ELSEWHERE IN
THIS FORM 10-K, INCLUDING THE DOCUMENTS INCORPORATED BY REFERENCE. ACTUAL
RESULTS COULD DIFFER MATERIALLY FROM RESULTS REFERRED TO IN THE FORWARD-LOOKING
STATEMENTS. IN ADDITION, IMPORTANT FACTORS TO CONSIDER IN EVALUATING SUCH
FORWARD-LOOKING STATEMENTS INCLUDE CHANGES IN EXTERNAL MARKET FACTORS, CHANGES
IN THE COMPANY'S BUSINESS OR GROWTH STRATEGY OR AN INABILITY TO EXECUTE ITS
STRATEGY DUE TO CHANGES IN ITS INDUSTRY OR THE ECONOMY GENERALLY. IN LIGHT OF
THESE RISKS AND UNCERTAINTIES, THERE CAN BE NO ASSURANCES THAT THE RESULTS
REFERRED TO IN THE FORWARD-LOOKING STATEMENTS CONTAINED IN THIS FORM 10-K WILL
IN FACT OCCUR. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY REVISE THESE
FORWARD-LOOKING STATEMENTS TO REFLECT ANY FUTURE EVENTS OR CIRCUMSTANCES.
2
PART 1
ITEM 1. BUSINESS
OVERVIEW
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. 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
development 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.
HealthExtras intends to be the leading Internet-based seller of health
and disability benefit programs. We design and develop membership programs,
which are marketed directly to consumers over the Internet at our website,
www.healthextras.com. At our website, consumers can enroll as members of
HealthExtras and tailor their benefit packages to best suit their needs and
circumstances. By joining HealthExtras, members can address critical gaps in
their insurance protection. Those gaps have traditionally not been addressed by
insurance agents or brokers due to the low price point of that protection and
the high costs associated with that distribution channel. We believe we are the
first company to develop and sell Internet-based membership programs offering
products and services that incorporate health and disability benefits. We have
contracted with insurance companies to underwrite the insurance components of
our programs. As a result, we do not assume any insurance underwriting risk. The
financial responsibility for the payment of claims resulting from a qualifying
disability, or other event covered by the insurance features of our programs, is
borne by third-party insurers. All of the insurance and service features
included in our membership programs are supplied by outside vendors. Since
launching our programs in January 1999, and through December 31, 1999, we have
enrolled over 105,000 program members.
The features of membership in HealthExtras include health related
services that can be utilized in the absence of a qualifying disability, medical
condition or organ transplant. These include unlimited access to a nurse-advice
line, air-evacuation in the event of qualifying emergency while traveling and
access to cost savings through the national health care provider network. In the
event of a qualifying disability, medical condition or organ transplant,
HealthExtras offers consultation services to ensure that the benefits payable
under the insurance features are used appropriately.
3
The Internet is an increasingly significant medium for communication,
information and commerce. International Data Corporation, commonly referred to
as IDC, estimates that there were 97 million Internet users worldwide at the end
of 1998 and anticipates that number will grow to approximately 320 million users
by the end of 2002. In addition, IDC estimates that the worldwide consumer
electronic commerce market is expected to grow from approximately $11 billion in
1998 to approximately $94 billion in 2002. That growth is being driven by a
number of factors, including:
* A growing base of PCs in the home and workplace;
* Improvements in network security, infrastructure and bandwidth;
* Faster and less expensive Internet access;
* Increases in the quantity and quality of content available on the
Internet;
* The overall increase in public awareness of the Internet; and
* The convenience, timeliness and reduced costs of electronic commerce.
Over the last few years, consumers have significantly increased their
usage of the Internet and expanded the categories of products and services they
purchase over the Internet. A new class of Internet-based companies has emerged
to address these online opportunities. These companies are focusing on such
areas as books, CDs, videocassettes, airline tickets, online stock trading and,
increasingly, other consumer financial products and services.
OUR MARKET
According to Forrester Research, a leading e-commerce and technology
research firm, Internet-influenced sales of insurance will grow from $1.5
billion in 1998 to $11.0 billion in 2003. In addition, Booz, Allen & Hamilton,
Inc. has estimated that the cost of distribution of insurance products over the
Internet can be as much as 71% less than the distribution costs of products
through traditional brokers and agents. We believe our programs are well-suited
for delivery over the Internet because:
* health and disability benefits are information-based products that
need neither physical shipment nor warehousing of merchandise;
* the cost advantages and direct contact with customers afforded by the
Internet enable us to target and serve segments of the market which
would not be as profitable if they had to be accessed through large
sales staffs and costly local offices;
* effective two-way communication flow via the Internet facilitates
interaction with consumers and rapidly delivers feedback on consumer
preferences; and
* the Internet provides customers with convenience, privacy and control
over the process of researching and pricing benefits, without the
pressure of a commissioned agent.
Further, we believe that the Internet provides us with significant
opportunities in the direct marketing of our benefit programs, including the
ability to:
* evaluate and respond rapidly to consumer reactions to marketing
programs and product offerings;
* target the most attractive customer segments and customize
advertising to them across different websites; and
* provide customers flexibility to customize benefit programs.
4
The market of health and disability insurance is large and continues to
grow. We believe that the demand for insurance products will grow and be driven
by:
* significant growth in Internet commerce, through which more consumers
will have access to alternatives to traditional insurance products
and distribution channels;
* a growing awareness by consumers of their financial exposure to
catastrophic events, due to limitations in their insurance coverage;
and
* the growth in elective employee benefit plans which incorporate a
variety of insurance options.
THE HEALTHEXTRAS OPPORTUNITY
Many individuals and families are financially exposed to the costs of
catastrophic injuries and illnesses. According to Employee Benefit Research
Institute, more than 60% of insured Americans are covered by policies that limit
overall lifetime health benefits to $1.0 million or less and fewer than half of
American workers covered by group health insurance are covered by disability
policies. Most disability insurance is limited to short-term income replacement
and does not address longer-term financial security. Thus, individuals covered
by employer-sponsored health plans frequently have a significant amount of their
net worth exposed to loss through catastrophic illness or injury. In addition,
many uninsured Americans lack an effective means of accessing catastrophic
coverage because the comparatively low premiums associated with those products
make their commission yield unattractive to agents and brokers. As a result,
these products often are not actively marketed.
In response to these market opportunities, HealthExtras began to
develop membership program descriptions including coverage features, health
services, levels of benefits, exclusions and age parameters. HealthExtras sought
out insurers and reinsurers to underwrite specific features intended to be
included in its membership program. At its own expense, HealthExtras had group
policies filed in all fifty states and has continued to monitor progress and
respond to changes requested in the regulatory process. HealthExtras also
established the qualification provisions that allow cardholders of our
participating financial institutions to be group members through membership in
HealthExtras.
BUSINESS STRATEGY
We are an Internet-based seller of health and disability benefit
programs. The Internet represents a more cost-effective marketing and operating
platform for our business which can eliminate a significant percentage of the
costs associated with commission-driven distribution systems. Accordingly, the
Internet enhances our ability to provide access to affordable health and
disability benefit programs. Elements of our strategy include:
Become the Leading Online Seller of Health and Disability Benefit
Programs.
We are moving aggressively to capture a leading share of the Internet
segment of the health and disability market. We are positioned to promote
membership features of HealthExtras, including health and disability benefits,
that historically have been relatively uneconomic to offer to consumers through
traditional, commission-driven distribution channels. By leveraging our
membership base to obtain group rates, we are able to offer benefits to members
at a cost which we believe is less than they would have to pay individually for
comparable benefits.
Promote HealthExtras as the National Brand for Health and Disability
Benefits.
Through our exclusive association with Christopher Reeve, we have the
opportunity to achieve recognizable brand identity for our membership programs.
We intend to continue to expand our brand marketing aggressively through the
Internet, television, radio and print activities.
5
Develop Strategic Marketing Relationships.
We have established strategic marketing relationships with six of the
nation's largest credit card issuing banks for access to their customers. We
have entered into marketing programs with selected Internet portals,
insurance-related websites, and other websites with attractive demographic
profiles.
Continue to Develop and Arrange for the Sale of Additional Innovative Health
and Disability Programs to Members.
We are continuing to develop an expanded list of insurance and service
options for inclusion in our membership programs. These additional products
would provide flexibility in coverage amounts to our program members and address
additional insurance needs.
BRAND DEVELOPMENT
Christopher Reeve
Christopher Reeve has entered into an exclusive agreement to assist
HealthExtras in developing products, making consumers aware of various
catastrophic events that could threaten their families' security and promoting
the HealthExtras brand. Mr. Reeve appears in a number of television, radio and
print advertisements to promote HealthExtras programs and our website.
We have an agreement with Cambria Productions, Inc. f/s/o Christopher
Reeve, which had an initial three-year term from July 8, 1997. This agreement
has been extended for an additional two-year term, to July 8, 2002.
HealthExtras has exclusive rights to use the advertisements and
promotional materials involving Mr. Reeve that it develops for television,
radio, Internet and print, including newspapers, magazines, direct mail and
other consumer print materials, but excluding life-size cut-outs, billboards and
shelf-facing materials, during the term of the agreement and for a 10-year
annuity period thereafter, within the United States and its possessions,
territories and commonwealth. Further, under the agreement, Christopher Reeve
shall not promote, create commercials, or endorse any other product which
combines credit cards and health-related benefits; however, Mr. Reeve may
perform in television or productions sponsored by competitive companies and
products and may appear in promotions for such programs.
Mr. Reeve has the absolute right to approve all advertisements created
under the agreement, or to give a notice of disapproval. If Mr. Reeve gives
proper disapproval notice and the parties are unable to agree as to the
advertisement content, either party may terminate the agreement.
HealthExtras is required to make payments for Mr. Reeve's services
based on the number of persons who purchase a HealthExtras benefit program,
subject to the payment of guaranteed amounts. Mr. Reeve's representative has the
right to terminate the agreement immediately upon giving notice to HealthExtras
if any payment due under the agreement is not received within 30 days of its due
date. In such case, HealthExtras relinquishes any right to use any materials
previously created with Mr. Reeve's likeness.
STRATEGIC MARKETING RELATIONSHIPS
We have established strategic marketing relationships with six of the
nation's largest credit card issuing banks for access to their customers. These
banks are assisting us in establishing brand name recognition and driving
traffic to our website with their installed base of customers, which we estimate
represents more than 55 million households. In addition, we have established
marketing relationships with selected Internet content sites, electronic
commerce sites and Internet portals. These relationships drive traffic to our
website and increase our brand name recognition.
6
These arrangements provide for various marketing initiatives,
including, statement inserts, statement messages, banner placements and e-mail.
These communications feature Christopher Reeve, provide information about
HealthExtras benefit programs and promote our website. In addition, our bank
partners may establish links from their websites to the HealthExtras website.
HealthExtras compensates those banks based principally on the benefit programs
purchased in response to these communications.
Under the contracts which govern our relationships with our bank
partners, the banks have the right to review and approve all marketing materials
and to determine whether to send those materials to customers. HealthExtras pays
for the marketing material used and generally compensates the banks based on the
purchases of HealthExtras benefit programs by bank customers.
The contracts are typically for a term of 12 months, with automatic
annual renewal unless cancelled upon written notice 30 or 90 days prior to an
anniversary date. Some contracts also provide for termination by either party
without cause upon 30 or 90 days prior written notice.
PRODUCTS OFFERED
Membership in HealthExtras offers access to various combinations of
health and disability benefits. Further, we seek to provide flexibility for
members to customize the package of benefits included in their HealthExtras
program to meet their individual needs. HealthExtras does not assume any
underwriting risks for the benefits included in its programs. The current
benefits which can be obtained through membership in HealthExtras include:
* Catastrophic Disability. This provides a $1 million to $2 million
cash payment to members who become permanently disabled as the
result of an accident
* Excess Medical. This provides program members an additional $5
million in health insurance coverage after the exhaustion of the $1
million lifetime limit on a member's primary health insurance
coverage.
* Organ Transplant. Many employer-sponsored health insurance plans
contain an embedded limitation on organ transplant coverage. The
organ transplant benefit provides up to $250,000 to cover expenses
for an organ transplant in excess of a member's primary health
insurance coverage.
* Out of Area Expense Reimbursement. This provides up to $2,500 per
year in reimbursements for co-payments and deductibles for health
services furnished to members when they are over 100 miles from
home.
* Emergency Evacuation and Repatriation. This provides a member who
needs emergency medical treatment with up to $50,000 of coverage
for air ambulance transportation to an appropriate medical facility
abroad or in the United States.
* 24-Hour Nurse Consultation. This provides access to general medical
information from a centralized nursing staff 24 hours per day, 7
days per week, through a toll-free telephone number. This service
does not provide any diagnosis of medical conditions, nor does it
provide or control medical services.
* Provider Network Access. This allows members to receive the
discounts or the price concessions for medical services available
through the United Payors & United Providers, Inc. nationwide
network of medical care providers. The United Payors & United
Providers, Inc. network includes over 2,500 hospitals and 150,000
physicians.
The significant majority of HealthExtras' revenue and membership to
date is based on benefit combinations featuring the catastrophic disability
product.
7
OTHER STRATEGIC RELATIONSHIPS
Reliance National Insurance Company
Our relationship with Reliance National is governed by a Program
Administrator's Agreement between HealthExtras and Reliance National. This
agreement runs through February 28, 2002. Under this agreement, Reliance
National agreed to file the underlying benefit insurance policies in all 50
states and to use its best efforts to obtain approvals from the various state
insurance departments. Reliance National identifies for HealthExtras the
regulatory status in the various states for the insurance coverage it provides.
Reliance National is not, however, obligated to issue insurance under this
agreement. Also, Reliance National provides marketing and sales expertise for
the HealthExtras benefits programs. HealthExtras is required to pay Reliance
National for the cost of the insurance coverage provided to HealthExtras program
members. HealthExtras maintains a prepaid balance with respect to the insurance
coverages obtained from Reliance National.
Under this agreement, Reliance National has appointed HealthExtras as
administrator and designated the Sklover Group, Inc. as the program manager. The
Sklover Group is an independent insurance agent. HealthExtras has no authority
to adjust, compromise, settle or pay any claim made on the insurance policies.
HealthExtras maintains a toll free telephone number to provide its members
convenient access to information; however, all inquiries regarding policy
certificate holder services, including claim inquiries, are referred to the
licensed program manager.
This agreement gives Reliance National the right to suspend
HealthExtras as administrator or terminate the agreement based on an inability
to obtain and maintain in force reinsurance satisfactory to Reliance National
and in various circumstances pertaining to HealthExtras, for example, an
administrative accusation against it for violation of insurance laws, a default
in its duties and responsibilities, excessive consumer complaints, or
insolvency. In addition, Reliance National could unilaterally decide to stop
issuing policies for our programs at any time.
United Payors & United Providers, Inc.
Network Access
Our relationship with United Payors & United Providers, Inc. enables us
to offer our program members access to the price concessions for medical
services available through the United Payors & United Providers, Inc. network of
health care providers. This network consists of over 2,500 hospitals and 150,000
physicians throughout the United States.
HealthExtras has entered into a contract with United Payors & United
Providers, Inc. to allow HealthExtras program members to access, subject to
various criteria, the United Payors & United Providers, Inc. network of health
care providers. United Payors & United Providers, Inc. has the unilateral right
to revise the criteria for network access. In exchange, we have agreed to pay
United Payors & United Providers $1.00 per program 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 program member per month in the
fourth year of continued membership and thereafter. However, we can terminate
these payments by conveying $25 million in market value of our common stock to
United Payors & United Providers, Inc.
The contract contains mutual confidentiality and indemnification
provisions. The contract terminates on December 31, 2003, but may be terminated
prior to that time by either party upon breach of a provision of the contract,
provided the party gives the breaching party 30 days written notice of the
breach and the breaching party fails to correct the breach.
8
ADMINISTRATIVE SERVICES
HealthExtras has relied on United Payors & United Providers, Inc. to
furnish operating and administrative services and facilities necessary to its
business, which include personnel, office space, furniture and equipment,
telephone service, both voice and facsimile, and computer capabilities.
HealthExtras reimburses United Payors & United Providers, Inc. on a cost basis
for these services. In December 1999, HealthExtras entered into a sublease for
office space with United Payors & United Providers. In addition, effective April
1, 2000 all employees of United Payors & United Providers, Inc. whose services
are devoted full time to HealthExtras will become our employees. From that date,
services to be provided by United Payors & United Providers, Inc. will be
limited primarily to services relating to information technology and
communications. Compensation to United Payors & United Providers, Inc. for such
services will be based on a cost plus fee basis.
The Chairman of the Board of HealthExtras was also the Chairman of the
Board and Co-Chief Executive Officer of United Payors & United Providers, Inc,
until its merger with a subsidiary of BCE Emergis Inc. on March 28, 2000.
COMPETITION
Since HealthExtras programs incorporate insurance benefits, we consider
that our programs compete with those of online and traditional providers of
insurance products. The market for selling insurance products over the Internet
is new, rapidly evolving and intensely competitive. Current and new competitors
may be able to launch new websites at a relatively low cost.
We also face competition from the traditional distributors of
insurance, such as captive agents, independent brokers and agents, and direct
distributors of insurance. Insurance companies and distributors of insurance
products are increasingly competing with banks, securities firms and mutual fund
companies that sell insurance or alternative products to similar consumers.
Traditionally, regulation separated much of the activity in the financial
services industry. However, recent regulatory changes have begun to permit other
financial institutions to sell insurance also.
We potentially face competition from unanticipated alternatives to our
benefit programs from a number of large Internet companies and services that
have expertise in developing online commerce and in facilitating Internet
traffic, including America Online, Microsoft and Yahoo!. These potential
competitors could choose to compete with us directly or indirectly through
affiliations with insurers, insurance agents and brokers and other electronic
commerce companies. Other large companies with strong brand recognition,
technical expertise and experience in Internet commerce could also seek to
compete with us. Competition from these and other sources could harm our
business, results of operations and financial condition.
We believe that the principal competitive factors in our markets are
price, brand recognition, marketing expertise, website accessibility, ability to
fulfill customer purchase requests, customer service, reliability of delivery,
ease of use, and technical expertise and capabilities. Many of our current and
potential competitors, including Internet directories and search engines and
traditional insurance agents and brokers, have longer operating histories,
larger consumer bases, greater brand recognition and significantly greater
financial, marketing, technical and other resources than we. Certain of these
competitors may be able to secure products and services on more favorable terms
than we can obtain. In addition, many of these competitors may be able to devote
significantly greater resources than we for developing websites and systems,
marketing and promotional campaigns, attracting traffic to their websites and
attracting and retaining key employees.
Any of the firms described above could seek to compete against us
through traditional channels or by copying our products or business model.
Increased competition may result in reduced operating margins, loss of market
share and damage to our brand. We cannot assure you that we will be able to
compete successfully against current and future competitors or that competition
will not harm our business, results of operations and financial condition.
9
REGULATION
Since the HealthExtras programs include insurance benefits,
distribution of our programs must satisfy applicable legal requirements
relating, among other things, to policy form and rate approvals, the licensing
laws for insurance agents and insurance brokers, and the satisfaction by a
HealthExtras member who receives the insurance benefit of requisite criteria,
for example being a resident of a state which has approved the insurance policy.
We believe we satisfy applicable requirements. The underwriter of the insurance
benefits included in HealthExtras programs is responsible for obtaining
regulatory approvals for those benefits. An independent licensed insurance
agency is responsible for the solicitation of insurance benefits involved in
HealthExtras programs.
Complex laws, rules and regulations of each of the 50 states and the
District of Columbia pertaining to insurance impose strict and substantial
requirements on insurance coverage sold to consumers and businesses. Compliance
with these laws, rules and regulations can be arduous and imposes significant
costs. Each jurisdiction's insurance regulator typically has the power, among
other things, to:
* administer and enforce the laws and promulgate rules and regulations
applicable to insurance, including the quotation of insurance
premiums;
* approve policy forms and regulate premium rates;
* regulate how, by which personnel and under what circumstances an
insurance premium can be quoted and published; and
* regulate the solicitation of insurance and license insurance
companies, agents and brokers who solicit insurance.
State insurance laws and regulations are complex and broad in scope and
are subject to periodic modification as well as differing interpretations. There
can be no assurance that insurance regulatory authorities in one or more states
will not determine that the nature of our business requires us to be licensed
under applicable insurance laws. A determination to that effect or that we or
our business partners are otherwise not in compliance with applicable
regulations could result in fines, additional licensing requirements or
inability to market our products in particular jurisdictions. Such penalties
could significantly increase our general operating expenses and harm our
business. In addition, even if the allegations in any regulatory or legal action
against us turn out to be false, negative publicity relating to any such
allegation could result in a loss of consumer confidence and significant damage
to our brand. We believe that because many consumers and insurance companies are
not yet comfortable with the concept of purchasing insurance online, the
publicity relating to any such regulatory or legal issues could significantly
harm our business.
The distribution of our programs including an insurance component over
the Internet subjects us to additional risk as most insurance laws and
regulations have not been modified to clarify or amend their application to
Internet transactions. Currently, many state insurance regulators and
legislators are exploring the need for specific regulation of insurance sales
over the Internet. Such regulation could dampen the growth of the Internet as a
means of providing insurance services. Moreover, the application of laws
governing general commerce on the Internet remains largely unsettled, even in
areas where there has been some legislative action. It may take years to
determine whether and how existing laws such as those governing insurance,
intellectual property, privacy and taxation apply to the Internet. In addition,
the growth and development of the market for electronic commerce may prompt
calls for more stringent consumer protection laws and regulations that may
impose additional burdens on companies conducting business over the Internet.
Any new laws or regulations or new interpretations of existing laws or
regulations relating to the Internet could harm our business.
We believe that we are currently in compliance with applicable legal
requirements. However, the future regulation of insurance sales via the Internet
as a part of the new and rapidly growing electronic commerce business sector is
unclear. If additional state or federal laws or regulations are adopted, they
may have an adverse impact on us.
10
EMPLOYEES
As of December 31, 1999, we had 46 personnel whose services are devoted
full time to HealthExtras. As discussed under "Business - Other Strategic
Relationships - United Payors & United Providers, Inc." our personnel currently
are employees of United Payors & United Providers, Inc. This arrangement is for
our convenience. Effective April 1, 2000, we will establish employee benefits
similar to the benefits these personnel currently receive. At that time, they
will become direct employees of ours. We have never had a work stoppage. A
collective bargaining unit does not represent our personnel. We consider our
relations with our personnel to be good. Our future success will depend, in
part, on our ability to continue to attract, integrate, retain and motivate
highly qualified technical and managerial personnel, for whom competition is
intense.
ITEM 2. PROPERTIES
Our existing executive, administrative and operating offices are
located in approximately 2,473 square feet of office space in Rockville,
Maryland under a sublease with United Payors & United Providers, Inc. that
expires on February 28, 2001. We anticipate that we will be moving to new office
space in Rockville, MD consisting of approximately 19,700 square feet during the
second quarter of 2000. The new office space will be the subject of a sublease
with United Payors & United Providers, Inc. that expires May 2004. We believe
that the new office space is adequate for our existing needs and that suitable
additional space on commercially reasonable terms will be available as required.
ITEM 3. LEGAL PROCEEDINGS
From time to time we may become subject to legal proceedings and claims
in the ordinary course of business. Such legal proceedings and claims could
include claims of alleged infringement of third party intellectual property
rights and notices from state regulators that we may have violated state
regulations. Such claims, even if without merit, could result in the significant
expenditure of our financial and managerial resources. We are not aware of any
legal proceedings or claims that we believe will, individually or in the
aggregate, harm our business, financial condition or results of operations in
any material respect.
ITEM 4. SUBMISSION OF MATTERS FOR A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the quarter ended December 31, 1999.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock has been quoted on the Nasdaq National Market under
the symbol "HLEX" since the Company's initial public offering on December 14,
1999. The following table sets forth for the period indicated the high and low
sales prices for the common stock:
High Low
---- ---
1999
- ----
December 14 - December 31......... $12.38 $7.38
2000
- ----
First quarter (through March 21, 2000)... $11.97 $4.39
On March 21, 2000 the last closing sale price of the common stock, as
reported by the Nasdaq National Market was 5.25 per share. As of March 21, 2000,
the Company had approximately 3,418 stockholders of record. The Company did not
pay any cash dividends in 1999 and has no plans to do so in the foreseeable
future.
12
ITEM 6. SELECTED FINANCIAL DATA
(In thousands except per share data)
The following selected financial data has been derived from the audited
financial statements of the Company and its predecessor companies. The selected
financial data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the audited
financial statements, including notes thereto.
For the Period
October 23,
1996 (date of
inception) to For the Years Ended December 31,
December 31, --------------------------------
1996 1997 1998 1999
---- ---- ---- ----
Statement of Operations
Data:
Revenue ..................... $ -- $ -- $ -- $ 5,327
Direct expenses ............. -- -- -- 3,096
Product development and
marketing .................. 810 3,380 4,936 10,331
General and administrative .. 146 1,306 1,598 2,996
------ ------ ------ -------
Operating loss .............. (956) (4,686) (6,534) (11,096)
Interest expense, net ....... -- (556) (110) (351)
Other income (expense), net . (5) 589 -- (73)
------- -------- -------- ---------
Net loss .................... $ (961) $(4,653) $ (6,644) $(11,520)
======= ======== ========= =========
Basic and diluted net loss
per share $ -- $ -- $ -- $ (0.56)
Weighted average shares of
common stock outstanding ... -- -- -- 20,588
Pro forma basic and diluted
net loss per share (1) ...... $ (0.05) $ (0.26) $ (0.38) $ --
Pro forma weighted average
shares of common stock
outstanding (1) ............. 17,680 17,680 17,680 --
December 31,
---------------------------------
1996 1997 1998 1999
---- ---- ----- -----
Balance Sheet Data:
Cash and cash equivalents $ 3,526 $ 9,651 $ 219 $46,971
Total assets ............... 4,226 12,710 4,608 53,662
Total liabilities .......... 188 7,770 5,531 6,298
Total stockholders' (members')
equity (deficit)............ 4,038 4,940 (923) 47,364
- --------------
(1) Reflects the formation of HealthExtras, Inc. and the Reorganization as if
those events had taken place at the beginning of the period, except that no
effect is given to the investment by Capital Z Healthcare Holding Corp. in
HealthExtras prior to May 27, 1999.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Form 10-K may contain forward-looking statements (see "Certain
Factors That May Affect Future Operating Results or Stock Prices") within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements involve a number of risks and uncertainties. We
undertake no obligation to revise any forward-looking statements in order to
reflect events or circumstances that may arise after the date of this report.
Readers are urged to carefully review and consider the various disclosures made
in this report and in our other filings with the Securities and Exchange
Commission that attempt to advise interested parties of the risks and factors
that may affect our business.
OVERVIEW
We expect to generate a significant portion of our revenue from the
sale of membership programs which include supplemental health and disability
benefits. While product development has been ongoing for the past several years,
we began revenue-generating activities in January 1999. Prior to that time, we
were a development stage enterprise, which designed and test marketed various
benefit combinations. To date, we have primarily focused on the distribution of
our membership programs to bank customers and building recognition of our
program brand. Christopher Reeve is featured prominently in our online,
television and print marketing campaigns to build brand awareness. Our intent is
to effect a substantial portion of our program distributions over the Internet.
We believe our consumer research and marketing efforts have given us
valuable insight into the consumer perceptions and preferences regarding the
value and limitations of prevailing insurance products. Accordingly, we believe
that our programs are well positioned to address the needs of our targeted
market segments. As of December 31, 1999, more than 105,000 members had enrolled
in our programs.
Revenue is generated by payments for program benefits. The primary
determinant of HealthExtras' 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 the membership benefits, which are supplied by others, including the
insurance components. Revenue from program payments received, and related direct
expenses, are deferred to the extent that they are applicable to future periods
or to any refund guarantee we offer for an initial 90-day period. As of December
31, 1999, initial revenue was deferred for approximately 40,000 program members.
Direct expenses consist principally of bank marketing and processing
fees and the cost of benefits provided to program members. Direct expenses are a
function of the level of membership during the period and the specific set of
program features selected by members. The coverage obligations of our benefit
suppliers and the related expense are determined monthly, as are the remaining
direct expenses. HealthExtras has historically maintained a prepaid expense
balance with respect to the insurance features of its programs. Where amounts
are prepaid, direct expense is recognized based on the actual membership levels
in each program. These prepaid amounts were $879,300 and $731,800 at December
31, 1998 and December 31, 1999, respectively. 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.
We have entered into three-year employment agreements with five of our
officers. The annual base salaries under these arrangements range from $120,000
to $210,000, and one executive will be entitled to a bonus equal to one percent
of our after-tax profits. Our minimum aggregate payments under these employment
agreements are expected to be $837,000 annually.
14
Our limited history makes it difficult to evaluate our business and
prospects. We have incurred substantial operating losses since our inception,
and we intend to incur significant marketing and brand development expenses over
the next several years. We anticipate that our operating losses will continue in
the near term. There can be no assurance that we will generate significant
revenues or profitability in the future.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
HealthExtras incurred an operating loss of $11.5 million for the year
ended December 31, 1999. Revenue of $5.3 million consisted of annual program
member payments earned during the period. Cash collections for program
subscriptions through December 31, 1999 totaled $10.5 million. There was no
revenue in 1998.
Operating expenses for the year ended December 31, 1999 totaled $16.4
million. Direct expenses of $3.1 million consisted of the cost of obtaining the
benefits included in our programs, and marketing and other fees payable to our
distribution partners. These direct expenses represented 19% of operating
expenses for that period. For the year ended December 31, 1999, HealthExtras
incurred $10.3 million in product development and marketing expenses, or 63% of
total operating expenses, $4.3 million of which was incurred for the continuing
creative development of promotional and sales materials, including television
and print advertisements, and $1.1 million of which was product endorsement
costs. Media production expenses totaled $5.1 million for print and Internet
advertisement production and distribution. Market research expenses were
$380,000. General and administrative expenses for that period totaled $3.0
million or 18% of total operating expenses. These expenses included $1.7 million
in compensation and benefits and $205,000 in professional services.
Total operating expenses for the twelve months ended December 31, 1998
were $6.5 million. In 1998, total product development and marketing expenses
were $4.9 million, representing 75% of total operating expenses. These expenses
included $2.4 million for media development, consisting of $1.0 million in
product endorsement costs, $631,000 in business partner marketing materials,
$133,000 in test-marketing costs and approximately $650,000 in pre-production
creative costs. Production-related expenses in 1998 total $1.1 million, of which
$765,000 was in print advertisements and fulfillment materials and $330,000 was
for the production of television and radio promotions. Also in 1998, $626,000
was devoted to market research and product development consulting. Additional
costs of $237,000 of compensation expense, $324,000 in travel expense, and
$220,000 of other costs were incurred as product development and marketing
expenses. General and administrative expenses for the same period totaled $1.6
million, approximately 25% of total operating costs, and included approximately
$630,000 in compensation and $224,000 in professional and consulting fees.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Total operating expenses for the year ended December 31, 1998 were $6.5
million compared to $4.7 million for 1997. This difference was largely
attributable to a $1.6 million increase in product development and marketing
expenses, reflecting the implementation of marketing agreements, initial focus
groups and product evaluation. In 1997, product development and marketing
expenses included $674,000 for media development and $976,000 in market research
and product development consulting. Other costs for 1997 totaled approximately
$1,730,000, of which $513,000 was in compensation expense, $555,000 was in
travel expenses and approximately $660,000 was in other product and media
development costs. In 1998, product development and marketing expenses included
$2.4 million for media development, consisting of $1.0 million in product
endorsement costs, $631,000 in business partner marketing materials, $133,000 in
test-marketing costs and approximately $650,000 in pre-production creative
costs. Production-related expenses in 1998 totaled $1.1 million, of which
$765,000 was in print advertisements and fulfillment materials and $330,000 was
for the production of television and radio promotions. Also in 1998, $626,000
was devoted to market research and product development consulting. Additional
costs of $237,000 of compensation expense, $324,000 in travel expense, and
$220,000 of other costs were incurred as product development and marketing
expenses. General and administrative expenses were largely unchanged from year
to year. In 1997, these expenses included approximately $330,000 in compensation
and $541,000 in professional and consulting fees. In 1998, these expenses
included approximately $630,000 in compensation and $224,000 in professional and
consulting fees. Net other income decreased from $589,000 for the year ended
December 31, 1997 to a net expense of $100 for the year ended December 31, 1998.
This decrease reflected a reduction in realized securities trading gains.
Interest expense decreased from a net expense of $555,000 for the year
15
ended December 31, 1997 to $110,000 for the year ended December 31, 1998, as
more liquid assets were invested in interest-bearing instruments.
LIQUIDITY AND CAPITAL RESOURCES
Our operations since inception were funded primarily through capital
investments, advances from the Chairman of the Board of the Company and
borrowings under a line of credit. In December 1999, we completed the sale to
the public of 5,500,000 shares of the Company's common stock and received
proceeds (net of underwriting commissions and expenses of $5.6 million) of
approximately $54.9 million. As of December 31, 1999, we had $47.0 million in
cash and cash equivalents, $45.2 in working capital and no debt.
The primary commitment of our capital resources is to fund expenditures
relating to marketing and brand development we intend to incur over the next
several years and to fund the operating losses we anticipate in the near term.
We currently anticipate our available cash resources will be sufficient
to meet our presently anticipated working capital, capital expenditures and
business expansion requirements for approximately the next 24 months. There can
be no assurance that we will not require additional capital prior to the
expiration of that 24-month period. Even if such funds are not required, we may
seek additional equity or debt financing. We cannot assure you that such
financing will be available on acceptable terms, if at all, or that such
financing will not be dilutive to our stockholders.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement
on Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." We will be required to adopt SFAS No. 133
for the quarter ending March 31, 2001. Because we do not currently hold any
derivative financial instruments and do not expect to engage in hedging
activities, adoption of SFAS No. 133 is expected to have no material impact on
our financial condition or results of operations.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Software for Internal Use," which provides
guidance on accounting for the cost of computer software developed or obtained
for internal use. We have adopted this statement of position for the year ended
December 31, 1999. The adoption did not have a material impact on our financial
statements for the year ended December 31, 1999.
INTEREST RATE AND EQUITY PRICE SENSITIVITY
We are subject to interest rate risk on our short-term investments and
equity price risk in our marketable securities. We have determined that a 10%
move in the current weighted average interest rate of our short-term investments
and/or a 10% move in the weighted average market price of our marketable
securities would not have a material effect in our financial position, results
of operations and cash flows in the next year.
YEAR 2000
To date, we have not experienced any significant adverse effect related
to the Year 2000 issue. Due to our recent founding, we developed our systems and
technology in light of the Year 2000 problem, as opposed to many older systems
designed before this problem was known. On June 15, 1999, we completed our
review and testing of Year 2000 compliance for all of our internally developed
software, which include substantially all of the systems for the operation of
our website, customer interaction and transaction systems and our security,
monitoring and back-up capabilities. On May 31, 1999, we completed our
assessment of the Year 2000 readiness of our third party supplied software and
hardware, and of our vendors. During the assessment phase, we identified those
vendors critical to us, and received certifications of Year 2000 compliance or a
readiness disclosure statement from them. Testing was completed in the fourth
quarter of 1999.
While we have not experienced any significant adverse effects to date,
there can be no assurance that currently unidentified Year 2000 issues, if any,
will not arise and that these issues will not have a material adverse effect on
us.
16
CERTAIN FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS OR STOCK PRICES
FACTORS RELATED TO OUR BUSINESS
Because we have a limited operating history, our business prospects are
subject to a great deal of uncertainty
While our product development efforts have been ongoing for the past
two years, we only began revenue-generating activities in January 1999. This
limited history of operating our business means that our business prospects are
subject to a great deal of uncertainty and risks.
We have not been profitable and may not become profitable in the future
We have incurred operating losses since our inception. Because we plan
to continue to significantly increase our operating expenses in an attempt to
increase our member base, we will need to generate significantly higher revenues
to achieve profitability. Even if we achieve profitability, we may not be able
to maintain profitability in the future. In addition, as our business model
evolves, we expect to introduce a number of new products and services that may
or may not be profitable for us.
Our future profitability is dependent, to a significant extent, upon increased
consumer demand for additional products, which we are in the process of
developing or may develop in the future
Most of our revenue currently is derived from members purchasing
membership programs which include disability benefits. We believe our future
profitability is dependent upon achieving substantial increases in sales of our
programs, including those providing excess health insurance coverage and other
benefits we are developing or may develop in the future. To the extent these
products include insurance features, they generally will require regulatory
approvals. If we do not achieve these increased sales, we may never achieve
profitability.
If the sale of our membership programs over the Internet does not achieve
widespread consumer acceptance, we may never achieve profitability
To date, we primarily have promoted our membership programs through
mailings to credit card or other customers of banks. However, we intend to
significantly increase the distribution of our programs over the Internet. Thus,
our future profitability is dependent in large part on our ability to achieve
widespread consumer acceptance of purchasing our programs over the Internet. The
development of an online market for programs, such as those we offer, has only
recently begun, is rapidly evolving and likely will be characterized by an
increasing number of market entrants. Therefore, there is significant
uncertainty with respect to the viability and growth potential of this market
There can be no assurance that an online market for our programs will
develop or that consumers will significantly increase their use of the Internet
for obtaining the types of products and services included in the programs that
we sell. If an online market for these products fails to develop, or develops
more slowly than we expect, or if our programs do not achieve widespread market
acceptance, the prospects for our achieving profitable operations will be
significantly reduced.
If we lose one or more of our marketing relationships, our access to potential
customers would decline and sales and revenues would suffer
A substantial majority of all of our programs sold to date have been
through mailings sent by banks to their credit card and other customers. If we
lose one or more of our marketing relationships with credit card issuers and are
unable to replace those relationships with other marketing outlets, our access
to potential customers would decline and sales and revenues would suffer.
17
If we are not able to achieve a high level of brand recognition and consumer
demand for our programs, we will not achieve the level of revenues we need to be
profitable
There are a growing number of websites that offer consumers access to
information regarding insurance coverage alternatives and product pricing. Our
programs may be considered to compete with these and other distribution channels
for insurance products. We believe that broader recognition of the HealthExtras
brand and increased consumer demand for our programs are essential to our future
success. To attempt to achieve that recognition and demand, we intend to
continue to pursue an aggressive brand-enhancement strategy consisting of our
traditional print advertising, as well as national radio and television
advertising, online marketing and promotional efforts. This effort will require
significantly greater expenditures than we have been able to make to date. If
these expenditures do not result in a sufficient increase in revenues, we will
not achieve profitability.
The loss of our relationship with Christopher Reeve to promote our programs
could significantly impair our brand recognition and, thus, our ability to sell
our programs
Our agreement for Christopher Reeve to promote our programs currently
expires in July 2002. The loss of the Christopher Reeve identification with our
programs, upon termination of our contract or otherwise, could significantly
reduce our ability to sell our programs.
If we lose our relationships with our benefit providers, we could have
difficulty meeting demand for the products and services included in the programs
we sell
We are dependent on the providers of benefits included in our programs.
These benefits are provided pursuant to arrangements with Reliance National,
Chubb & Son and others that may be terminated on relatively short notice. If we
lose these relationships and are unable to replace them quickly and cost
effectively, we would not be able to satisfy consumer demand for our programs.
We may experience significant fluctuations in our quarterly results of
operations which will make it difficult for investors to make reliable
period-to-period comparisons and may contribute to volatility in our stock price
Our quarterly expenses have fluctuated significantly in the past, and
we expect our quarterly revenues and expenses to continue to fluctuate
significantly in the future. The causes for fluctuations could include, among
other factors:
* changes in acceptance levels for our benefit program by consumers;
* our levels of marketing expenditures;
* renewal rate experience for our benefit programs;
* the initiation of new or increased distribution methods, services and
products by our competitors;
* price competition by insurance companies in their sale of insurance
products; and
* the level of Internet use to purchase insurance or similar type
products.
We believe that quarter-to-quarter comparisons of our operating results
are not necessarily meaningful and not good indicators of our future
performance. Due to the above-mentioned and other factors, it is possible that
in one or more future quarters our operating results will fall below the
expectations of securities analysts and investors. If this happens, the trading
price of our common stock would likely decrease.
18
If we do not manage our growth effectively, we will not be able to operate
profitably
We only began offering our programs this year, and we have been
expanding our operations rapidly. Our growth strategy, if successful, will
result in further expansion. We can achieve profitable operation, however, only
if we are able to manage our growth effectively. Our growth in operations has
placed significant demands on our management and other resources, which is
likely to continue. Under these conditions, it is important for us to retain our
existing management and to attract, hire and retain additional highly skilled
and motivated officers, managers and employees and improve existing systems
and/or implement new systems.
We may not be successful in managing or expanding our operations or
maintaining adequate management, financial and operating systems and controls.
If the providers of the benefits included in our programs fail to provide
those benefits, we could become subject to liability claims by our program
members
We arrange for the provision by others of the benefits included in our
member programs. If the firms with which we have contracted to provide those
benefits fail to provide them as required, or are negligent or otherwise
culpable in providing them, we could become involved in any resulting claim or
litigation.
FACTORS RELATED TO REGULATION
If we fail to comply with all of the various and complex laws and regulations
governing our business, we could be subject to fines, additional licensing
requirements or the inability to market in particular jurisdictions
Complex laws, rules and regulations of each of the 50 states and the
District of Columbia pertaining to insurance impose strict and substantial
requirements on insurance coverage sold to consumers and businesses. Compliance
with these laws, rules and regulations can be arduous and imposes significant
costs. The underwriter of the insurance benefits included in HealthExtras
programs is responsible for obtaining and maintaining regulatory approvals for
those benefits. If the appropriate regulatory approvals for the insurance
benefits included in our programs are not maintained, we would have to stop
including those benefits. An independent licensed insurance agency is
responsible for the solicitation of insurance benefits involved in HealthExtras
programs. Each jurisdiction's insurance regulator typically has the power, among
other things, to:
* administer and enforce the laws and promulgate rules and regulations
applicable to insurance, including the quotation of insurance
premiums;
* approve policy forms and regulate premium rates;
* regulate how, by which personnel and under what circumstances, an
insurance premium can be quoted and published; and
* regulate the solicitation of insurance and license insurance
companies, agents and brokers who solicit insurance.
State insurance laws and regulations are complex and broad in scope and
are subject to periodic modification as well as differing interpretations. There
can be no assurance that insurance regulatory authorities in one or more states
will not determine that the nature of our business requires us to be licensed
under applicable insurance laws. A determination to that effect or that we or
our business partners are not in compliance with applicable regulations could
result in fines, additional licensing requirements or inability to market our
programs in particular jurisdictions. Such penalties could significantly
increase our general operating expenses and harm our business. In addition, even
if the allegations in any regulatory or legal action against us turn out to be
false, negative publicity relating to any such allegation could result in a loss
of consumer confidence and significant damage to our brand. We believe that
because many consumers and insurance companies are not yet comfortable with the
concept of purchasing insurance online, the publicity relating to any such
regulatory or legal issues could significantly reduce sales of our programs.
19
Regulation of the sale of insurance over the Internet and of electronic
commerce generally is unsettled, and future laws, regulations and
interpretations could hinder our ability to offer programs over the Internet
The distribution of our programs including an insurance component over
the Internet subjects us to additional risk as most insurance laws and
regulations have not been modified to clarify or amend their application to
Internet transactions. Currently, many state insurance regulators and
legislators are exploring the need for specific regulation of insurance sales
over the Internet. Such regulation could dampen the growth of the Internet as a
means of providing insurance services. Moreover, the application of laws
governing general commerce on the Internet remains largely unsettled, even in
areas where there has been some legislative action. It may take years to
determine whether and how existing laws such as those governing insurance,
intellectual property, privacy and taxation apply to the Internet. In addition,
the growth and development of the market for electronic commerce may prompt
calls for more stringent consumer protection laws and regulations that may
impose additional burdens on companies conducting business over the Internet.
Any new laws or regulations or new interpretations of existing laws or
regulations relating to the Internet could hinder our ability to offer programs
over the Internet.
We could be subject to legal liability based upon the information on our
website
Our members may rely upon the information published on our website
regarding insurance coverage, exclusions, limitations and ratings, and the other
benefits included in our programs. To the extent that the information we provide
is not accurate, we could be liable for damages. These types of claims could be
time-consuming and expensive to defend, divert management's attention, and could
cause consumers to lose confidence in our service. As a result, these types of
claims, whether or not successful, could harm our business.
FACTORS RELATED TO THE INTERNET AND ELECTRONIC COMMERCE
If we experience failures of, or capacity constraints in, our systems or the
systems of third parties on which we rely, sales of our programs likely would be
reduced and our reputation could be damaged
We use both internally developed and third party systems to operate the
Internet aspects of our business. If the number of users of our service
increases substantially, we will need to significantly expand and upgrade our
technology, transaction processing systems and network infrastructure. We do not
know whether we will be able to accurately project the rate or timing of any
increases, or expand and upgrade our systems and infrastructure to accommodate
any increases in a timely manner. Our ability to facilitate transactions
successfully and provide high quality customer service also depends on the
efficient and uninterrupted operation of our computer and communications
hardware systems. Our service has experienced periodic system interruptions, and
it is likely that these interruptions will continue to occur from time to time.
Additionally, our systems and operations are vulnerable to damage or
interruption from human error, natural disasters, power loss, telecommunication
failures, break-ins, sabotage, computer viruses, acts of vandalism and similar
events. We may not carry sufficient business interruption insurance to
compensate for losses that could occur. Any system failure that causes an
interruption in service or decreases the responsiveness of our service would
impair our revenue-generating capabilities, and could damage our reputation and
our brand name.
If we are unable to safeguard the security and privacy of our program members'
information, our reputation would be damaged and we could be subject to
litigation and liability
A significant barrier to electronic commerce and online communications
has been the need for secure transmission of confidential information over the
Internet. Our ability to secure the transmission of confidential information
over the Internet is essential in maintaining consumer confidence in our
service. In addition, because we handle confidential and sensitive information
about our program members, any security breaches would damage our reputation and
could expose us to litigation and liability. We cannot guarantee that our
systems will prevent security breaches.
20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(Included in Management's Discussion and Analysis of Financial
Condition and Results of Operations)
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our audited Financial Statements are contained in a separate section of
this Annual Report on Form 10-K on pages F-1 through F-13, attached hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLSOURE
None
21
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required under this item is contained in the section
entitled "Executive Officers and Directors" in our 1999 Proxy Statement and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information required under this item is contained in the sections
entitled "Directors Compensation" and "Executive Compensation" in our 1999 Proxy
Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required under this item is contained in the section
entitled "Stock Ownership" in our 1999 Proxy Statement and is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required under this item is contained in the section
entitled "Certain Transactions" in our 1999 Proxy Statement and is incorporated
herein by reference.
22
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report
(1) Financial Statements
Report of Independent Accountants
Balance Sheets as of December 31, 1998 and 1999
Statements of Operations and Comprehensive Loss for the years
ended December 31, 1997, 1998 and 1999 Statements of Stockholders'
(Members') Equity (Deficit) for the years ended December 31, 1997,
1998 and 1999 Statements of Cash Flows for the years ended
December 31, 1997, 1998 and 1999 Notes to Financial Statements
(2) All schedules have been omitted because they are not applicable,
not required or the information is included elsewhere in the
Company's financial statements or notes thereto.
(b) Reports on Form 8-K
None
(c) Exhibits
The following exhibits are filed as part of this report unless noted
otherwise:
Exhibit No. Description
----------- --------------------------------------------------
2.1 Form of Reorganization Agreement by and among HealthExtras,
Inc., HealthExtras, LLC and Capital Z Healthcare Holding
Corp (1)
3.1(a) Certificate of Incorporation of HealthExtras, Inc(1)
3.1(b) Form of Amended and Restated Certificate of Incorporation(1)
3.2 Bylaws of HealthExtras, Inc.(1)
4.1 Specimen Stock Certificate of HealthExtras, Inc.
4.2 Form of Stockholders' Agreement(1)
10.1 Form of Employment Agreement between HealthExtras, Inc. and
David T. Blair(1)
10.2 Form of Employment Agreement between HealthExtras, Inc. and
certain Executive Officers (1)
10.3 Program Administrator's Agreement by and between
HealthExtras LLC and Reliance National Insurance Company (1)
10.4 Agreement between United Payors & United Providers, Inc. and
HealthExtras, Inc. (filed herewith)
10.5 Agreement by and between United Payors & United Providers,
Inc. and HealthExtras, LLC.re: network access(1)
10.6 Agreement by and between Cambria Productions, Inc. f/s/o
Christopher Reeve and HealthExtras, Inc. (1) (2)
10.7 Indemnification Agreement (1)
10.8 Sublease Agreement by and between United Payors & United
Providers, Inc. and HealthExtras, Inc. (filed herewith)
10.9 Form of HealthExtras, Inc. 1999 Stock Option Plan (1)
10.10 Form of Registration Rights Agreement (1)
27.1 Financial Data Schedule (filed herewith)
- --------------
(1) Incorporated herein by reference into this document from the Exhibits to the
Form S-1 Registration Statement, as amended, Registration No. 333-83761,
initially filed on July 26, 1999.
(2) Confidential treatment requested for portion of agreement pursuant to
Section 406 of Regulation C. promulgated under the Securities Act of 1933, as
amended.
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
HEALTHEXTRAS, INC.
Date March 29, 2000 By: /s/ David T. Blair
-----------------------
David T. Blair
Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
Date: March 29, 2000 By: /s/ Thomas L. Blair
-----------------------
Thomas L. Blair
Chairman of The Board
Date: March 29, 2000 By: /s/ David T. Blair
-----------------------
David T. Blair
Chief Executive Officer and Director
Date: March 29, 2000 By: /s/ Michael P. Donovan
-----------------------
Michael P. Donovan
Chief Financial Officer and
Chief Accounting Officer
Date: March 29, 2000 By: /s/ Julian A. L. Allen
-----------------------
Julian A. L. Allen
Director
Date: March 29, 2000 By: /s/ Bette B. Anderson
----------------------
Bette B. Anderson
Director
Date: March 29, 2000 By: /s/ William E. Brock
-----------------------
William E. Brock
Director
Date: March 29, 2000 By: /s/ Thomas J. Graf
-------------------
Thomas J. Graf
Director
Date: March 29, 2000 By: /s/ Julia M. Lawler
-----------------------
Julia M. Lawler
Director
Date: March 29, 2000 By: /s/ Karen E. Shaff
-----------------------
Karen E. Shaff
Director
Date: March 29, 2000 By: /s/ Paul H. Warren
-----------------------
Paul H. Warren
Director
Report of Independent Accountants
To the Board of Directors and Stockholders of HealthExtras, Inc:
In our opinion, the accompanying balance sheets, the related statements of
operations and comprehensive loss, changes in stockholders' (members') equity
(deficit), and of cash flows, present fairly, in all material respects, the
financial position of HealthExtras, Inc. at December 31, 1998 and 1999, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
McLean, Virginia
March 2, 2000
F-1
HealthExtas, Inc.
Balance Sheets
December 31, December 31,
1998 1999
------------ -------------
Current assets:
Cash and cash equivalents .................... $ 219,285 $ 46,971,106
Certificate of deposit ....................... 700,000 --
Marketable securities of a related party ..... 1,144,255 664,984
Accounts receivable .......................... -- 62,795
Deferred charges:
Direct .................................... 879,300 1,203,854
Marketing and promotion ................... 1,110,000 2,316,491
Other current assets ......................... -- 240,153
------------ ------------
Total current assets .................... 4,052,840 51,459,383
Deferred marketing and promotion charges ...... 555,000 --
Fixed assets, net ............................. -- 1,904,847
Other assets .................................. -- 297,853
------------ ------------
Total assets ............................ $ 4,607,840 $ 53,662,083
============ ============
Current liabilities:
Accounts payable and accrued expenses ....... $ 426,396 $ 1,056,777
Accrued benefit expense ...................... 546,562 --
Marketing expenses payable ................... 1,016,000 4,000
Contribution payable ......................... 200,000 --
Deferred revenue ............................. 257,746 5,237,210
Due to member ................................ 1,334,429 --
------------ ------------
Total current liabilities ............... 3,781,133 6,297,987
Line of credit ............................... 1,750,000 --
------------ ------------
Total liabilities ....................... 5,531,133 6,297,987
------------ ------------
Commitments
Stockholders' (members') equity (deficit)
Preferred stock, $0.01 par value, 5,000,000
shares authorized, none issued ............ -- --
Common stock, $0.01 par value, 100,000,000
shares authorized, 27,600,000 shares issued
and outstanding at December 31, 1999 ...... -- 276,000
Additional paid-in capital ................... -- 48,045,635
Accumulated deficit .......................... -- (719,976)
Members' deficit ............................. (1,535,232) --
Deferred compensation ........................ -- (370,232)
Accumulated other comprehensive income ....... 611,939 132,669
------------ ------------
Total stockholders' (members') equity
(deficit) ............................. (923,293) 47,364,096
------------- ------------
Total liabilities and stockholders'
(members')equity (deficit) ............ $ 4,607,840 $ 53,662,083
============ ============
The accompanying notes are an integral part of these financial statements
F-2
HealthExtras, Inc.
Statements of Operations and Comprehensive Loss
For the years ended December 31,
1997 1998 1999
--------- --------- -----------
Revenue ................................... $ -- $ -- $ 5,326,527
------------ ------------ ------------
Direct expenses ........................... -- -- 3,095,397
Product development and marketing ......... 3,379,770 4,935,831 10,331,163
General and administrative (includes
expenses from related parties of
$182,364, $964,023 and $2,287,832 for
the years ended December 31,
1997, 1998 and 1999, respectively) ...... 1,306,519 1,597,660 2,996,345
------------ ------------ ------------
Total operating expenses .............. 4,686,289 6,533,491 16,422,905
------------ ------------ ------------
Operating loss ........................ (4,686,289) (6,533,491) (11,096,378)
Interest income (expense), net (includes
imputed interest applicable
to related-party transactions of
$483,191, $238,479 and $268,064 for
the years ended December 31, 1997,
1998, and 1999, respectively) ........ (555,651) (110,273) (350,487)
Other income (expense), net ............... 589,228 (100) (73,234)
------------ ------------ ------------
Net loss ............................. (4,652,712) (6,643,864) (11,520,099)
Unrealized holding gains (losses) on
marketable securities arising
during the period .................... 71,000 542,189 (479,270)
------------ ------------ ------------
Comprehensive loss ................... $ (4,581,712) $ (6,101,675) $(11,999,369)
============ ============ ============
Basic and diluted net loss per share ...... $ -- $ -- $ (0.56)
Weighted average shares of common
stock outstanding
(in thousands) ....................... -- -- 20,588
Pro forma basic and diluted net loss
per share ............................ $ (0.26) $ (0.38) $ --
Pro forma weighted average shares of common
stock outstanding
(in thousands) ....................... 17,680 17,680 --
The accompanying notes are an integral part of these financial statements
F-3
HealthExtras, Inc.
Statement of Changes in Stockholders' (Members') Equity (Deficit)
HealthExtras LLC HealthExtras, Inc.
------------------------ -----------------------------------------------------------------------
Accumulated Common Stock Accumulated
Other ------------ Other
Members Comprehensive Additional Comprehensive
Capital Income Paid In Income Accumulated Deferred
(deficit) Loss Shares Amount Capital (Loss) Deficit Compensation Total
------- -------- ---------- -------- ----------- ----------- ------------ ------------ -----------
Balance at
December
31, 1996 $ 4,039,674 $ (1,250) -- $ -- $ -- $ -- $ -- $ -- $ 4,038,424
Additional
capital
contributions
by members 5,000,000 -- -- -- -- -- -- -- 5,000,000
Unrealized gain
on marketable
securities -- 71,000 -- -- -- -- -- -- 71,000
Noncash interest
expense 483,191 -- -- -- -- -- -- -- 483,191
Net loss (4,652,712) -- -- -- -- -- -- -- 4,652.712)
----------- ------- ------ ------- -------- ------ -------- -------- ---------
Balance at
December
31, 1997 4,870,153 69,750 -- -- -- -- -- -- 4,939,903
Unrealized gain
on marketable
securities -- 542,189 -- -- -- -- -- -- 542,189
Noncash interest
expense 238,479 -- -- -- -- -- -- -- 238,479
Net loss (6,643,864) -- -- -- -- -- -- -- (6,643,864)
----------- -------- ------ ------- -------- ------ -------- --------- ---------
Balance at
December
31, 1998 (1,532,232) 611,939 -- -- -- -- -- -- (923,293)
Grant of
effective
member
interests to
management,
net of deferred
compensation of
$370,232 97,341 -- -- -- -- -- -- -- 97,341
Capital
contribution
by new member 5,000,000 -- -- -- -- -- -- -- 5,000,000
Unrealized gain
(loss) on
marketable
securities -- (491,817) -- -- -- 12,547 -- -- (479,270)
Noncash interest
expense and
loan guarantee
fees 268,063 -- -- -- -- -- -- -- 268,063
Net loss for the
period from
January 1, 1999
to December 16,
1999 (see Note 1) (10,800,123) -- -- -- -- -- -- -- (10,800,123)
Reorganization,
December 17,
1999 (see
Note 1) 6,969,951 (120,122) 22,100,000 221,000 (6,820,719) 120,122 -- (370,232) --
Net proceeds
from initial
public offering
(see Note 1) -- -- 5,500,000 55,000 54,866,354 -- -- -- 54,921,354
Net loss for the
period from
December 17, 1999
to December 31,
1999 -- -- -- -- -- -- (719,976) -- (719,976)
-------- ------ ---------- ------- ---------- ------- --------- --------- ---------
Balance at
December 31,
1999 $ -- $ -- 27,600,000 $276,000 $48,045,635 $132,669 $(719,976) $(370,232) $47,364,096
======== ====== ========== ======== =========== ======= ========== ========== ===========
The accompanying notes are an integral part of these financial statements
F-4
HealthExtras, Inc.
Statements of Cash Flows
For the years ended December 31,
1997 1998 1999
----------- ------------ ------------
Cash flows from operating activities:
Net loss ....................................... $ (4,652,712) $ (6,643,864) $(11,520,099)
Depreciation expense ........................... -- -- 89,889
Noncash compensation expense and fees .......... -- -- 97,341
Change in deferred charges ..................... (2,775,000) 230,700 (976,045)
Noncash interest expense ....................... 483,191 238,479 268,064
Changes in assets and liabilities:
Accounts receivable .......................... -- -- (62,795)
Trading securities, net ...................... 494,375 -- --
Prepaid expenses and other assets ............ (1,437) 20,000 (538,006)
Accounts payable and accrued expenses ........ 201,635 73,901 630,381
Accrued benefit expense ...................... -- 546,562 (546,562)
Marketing expenses payable ................... 2,031,713 (1,015,713) (1,012,000)
Contribution payable ......................... 190,909 9,091 (200,000)
Deferred revenue ............................. -- 257,746 4,979,464
---------- ---------- -----------
Net cash used in operating activities ...... (4,027,326) (6,283,098) (8,790,368)
----------- ----------- -----------
Cash flows from investing activities:
Capital expenditures ........................... -- -- (1,994,736)
Deposits ....................................... 152,000 -- --
Maturity (purchase) of certificate of deposit .. -- (700,000) 700,000
Purchases of available for sale securities ..... (179,100) (338,341) --
Sales of available for sale securities ......... 20,750 -- --
----------- ----------- -----------
Net cash used in investing activities ...... (6,350) (1,038,341) (1,294,736)
------------ ----------- ------------
Cash flows from financing activities:
Proceeds from (repayment of) line of credit .... -- 1,750,000 (1,750,000)
Capital contributions .......................... 5,000,000 -- 5,000,000
Borrowings from (repayment to) member, net ..... 5,158,461 (3,860,282) (1,334,429)
Net proceeds from initial public offering ...... -- -- 54,921,354
---------- ----------- -----------
Net cash provided by (used in) financing
activities.................................. 10,158,461 (2,110,282) 56,836,925
---------- ----------- ----------
Net increase (decrease) in cash and cash
equivalents .................................... 6,124,785 (9,431,721) 46,751,821
Cash and cash equivalents at the beginning
of period ...................................... 3,526,221 9,651,006 219,285
--------- --------- ----------
Cash and cash equivalents at the end of period ... $ 9,651,006 $ 219,285 $46,971,106
=========== =========== ==========
Supplemental disclosure:
Cash paid for interest ......................... $ 131,515 $ 3,248 $ 181,729
The accompanying notes are an integral part of these financial statements
F-5
HEALTHEXTRAS, INC.
NOTES TO FINANCIAL STATEMENTS
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 development 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 Health Extras 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.
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.
F-6
HEALTHEXTRAS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
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:
1998 1999
----- -----
Historical cost ................. $ 532,316 $ 532,315
Gross unrealized holding gains... 611,939 132,669
---------- ----------
Total marketable securities ..... $1,144,255 $ 664,984
========== ==========
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.
F-7
HEALTHEXTRAS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
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 weighted average basic net loss per share is computed based on the
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 specif 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.
F-8
HEALTHEXTRAS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
Segment reporting
The Company operates in only one market segment as a provider of
supplemental health and disability benefit programs to individuals. The Company
has no major customers and operates only in the United States.
3. FIXED ASSETS
Fixed assets as of December 31, 1999 consist of the following:
Computer equipment ...................... $ 451,118
Furniture, fixtures and office equipment 88,217
Leasehold improvements in process ....... 1,455,401
----------
Total fixed assets ................. 1,994,736
Accumulated depreciation and amortization (89,889)
-----------
Fixed assets, net .................. $ 1,904,847
===========
Depreciation expense for the year ended December 31, 1999 was $89,889.
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:
Deferred tax assets (liabilities):
Deferred charges .......... $ (464,928)
Deferred revenue .......... 2,022,610
Net operating loss ........ 5,473
Valuation allowance ....... (1,563,155)
------------
Net deferred tax asset $ --
=============
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:
U.S. Federal Statutory tax rate ... (34.0%)
State tax, net of federal benefit.. (4.6)
Valuation allowance ............... 38.5
Other ............................. .1
-----
Effective tax rate ................ -%
=====
F-9
HEALTHEXTRAS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
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:
Net loss
As reported ..................... $11,520,099
Pro forma ....................... 11,693,258
Net loss per share
As reported - basic and diluted.. 0.56
Pro forma - basic and diluted.... 0.57
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:
Risk-free interest rate........ 4.7%
Expected years until exercise.. 5 years
Expected volatility............ 61.3%
Dividend yield................. -
F-10
HEALTHEXTRAS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
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.
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-time basis over the term of
the sublease.
Future minimum lease payments under the sublease are as follows:
2000..... $ 451,000
2001..... 602,000
2002..... 626,000
2003..... 657,000
2004..... 280,000
---------
Total... $2,616,000
=========
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 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.
F-11
HEALTHEXTRAS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
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.
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 $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.
F-12
HEALTHEXTRAS, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
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 an 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.