Notes
to Condensed Consolidated Financial Statements
(unaudited)
1.
Organization, Basis of Presentation and Summary of Significant Accounting Policies
In
this quarterly report, unless the context suggests otherwise, references to the “Company,” “we,” “us”
and “our” refer (1) prior to the February 13, 2013 closing of an initial public offering (“IPO”) of the
Class A common stock of Health Insurance Innovations, Inc. and related transactions, to Health Plan Intermediaries, LLC (“HPI”)
and its consolidated subsidiaries and (2) after the IPO and related transactions, to Health Insurance Innovations, Inc. and its
consolidated subsidiaries. The terms “HII”, “HPIH”, and “ICE” refer to the stand-alone entities
Health Insurance Innovations, Inc., Health Plan Intermediaries Holdings, LLC, and Insurance Center for Excellence, LLC, respectively.
The term “Secured” refers to (a) prior to or at the time of their July 17, 2013 acquisition by us, Sunrise Health
Plans, Inc., Sunrise Group Marketing, Inc. and Secured Software Solutions, Inc., collectively, and (b) following our July 17,
2013 acquisition, the entities described in (a) and the limited liability companies into which such entities were converted shortly
following such acquisition. The terms “HealthPocket” or “HP” refer to HealthPocket, Inc., our wholly owned
subsidiary which was acquired by HPIH on July 14, 2014. The term “ASIA” refers to American Service Insurance Agency
LLC, a wholly owned subsidiary which was acquired by HPIH on August 8, 2014. HPIH, ICE, Secured, HP and ASIA are consolidated
subsidiaries of HII.
Principles
of Consolidation and Basis of Presentation
The
accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles
in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of
the financial information and footnotes required by U.S. GAAP for complete financial statements. The condensed consolidated financial
statements include the accounts of Health Insurance Innovations, Inc., its wholly-owned subsidiaries, one of which is a Variable
Interest Entity (“VIE”), of which the Company is the primary beneficiary. All significant intercompany balances and
transactions have been eliminated in preparing the consolidated financial statements. The results of operations for business combinations
are included from their respective dates of acquisition.
Noncontrolling
interests are included in the condensed consolidated balance sheets as a component of stockholders’ equity that is not attributable
to the equity of the Company. We report separately the amounts of consolidated net loss or income attributable to us and noncontrolling
interests.
The
information included in this quarterly report, including the interim condensed consolidated financial statements and the accompanying
notes, should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2015. The year-end condensed balance sheet data was derived from audited
financial statements, but does not include all disclosures required by GAAP. The condensed consolidated results for the three
and nine months ended September 30, 2016 are not necessarily indicative of the results to be expected for any interim subsequent
period or for the year ending December 31, 2016.
As
an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”),
we benefit from certain temporary exemptions from various reporting requirements, including, but not limited to, not being required
to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations
regarding executive compensation in our periodic reports and proxy statements. We have also elected under the JOBS Act to delay
the adoption of new and revised accounting pronouncements applicable to public companies until such pronouncements are made applicable
to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with
public company effective dates. These exemptions will apply for a period of five years following the completion of our IPO which
closed on February 13, 2013. However, if the market value of our common stock that is held by non-affiliates exceeds $700 million
as of any June 30 before that time, we would cease to be an emerging growth company as of the following December 31.
Business
Description and Organizational Structure of the Company
Our
Business
We
are a developer, distributor and virtual administrator of affordable, cloud-based individual health and family insurance plans
(“IFP”) and supplemental products, which include short-term medical (“STM”) insurance plans and guaranteed-issue
and underwritten hospital indemnity plans.
STM
plans provide up to six, eleven or twelve months of health insurance coverage with a wide range of deductible and copay levels.
STM plans generally offer qualifying individuals insurance benefits for fixed short-term durations. STM plans feature a streamlined
underwriting process offering immediate coverage options. Generally, our IFP premiums are substantially more affordable than the
premiums of individual major medical (“IMM”) plans which offer lifetime renewable coverage.
Included
in IFP are hospital indemnity plans which are guaranteed-issue and underwritten plans that pay fixed cash benefits for covered
procedures and services for individuals under the age of 65. These highly customizable products are on an open provider network
without copayments or deductibles and do not have defined policy terms.
We
also offer a variety of additional insurance and non-insurance products such as pharmacy benefit cards, dental plans, vision plans,
cancer/critical illness plans, deductible and gap protection plans and life insurance policies that are frequently purchased as
supplements to IFP.
We
design and structure these products on behalf of insurance carriers and market them to individuals through our internal and external
distribution network. We manage member relations via our online member portal, which is available 24 hours a day, seven days a
week. Our online enrollment process allows us to aggregate and analyze consumer data and purchasing habits to track market trends
and drive product innovation.
As
the managing general underwriter of our individual health insurance plans and supplemental products, we receive all amounts due
in connection with the plans we sell on behalf of the providers of the services, third-party commissions and referral fees. We
refer to these total collections as premium equivalents, which typically represent a combination of premiums, fees for discount
benefit plans (a non-insurance benefit product that supplements or enhances an insurance product), fees for distributors, our
enrollment fees and third-party commissions and referral fees. From premium equivalents, we remit risk premium to carriers and
amounts earned by discount benefit plan providers, who we refer to as third-party obligors, such carriers and third-party obligors
being the ultimate parties responsible for providing the insurance coverage or discount benefits to the member. Our revenues consist
of the balance of the premium equivalents.
We
collect premium equivalents upon the initial sale of the plan and then monthly upon each subsequent periodic payment under such
plan. We receive most premium equivalents through online credit card or ACH processing. As a result, we have limited accounts
receivable. We remit the risk premium to the applicable carriers and the amounts earned by third-party obligors on a monthly basis
based on the respective compensation arrangements.
We
also provide consumers with access to health insurance information search and comparison technology through our website, HealthPocket.com.
This free website allows consumers to easily and clearly compare and rank all health insurance plans available for an individual,
family, or small business, empowering consumers to make health plan decisions and reduce their out of pocket costs. In addition,
the data aggregated by HealthPocket (“HP”) is used to research consumer needs and to measure product demand to help
us design and manufacture high-demand insurance products.
In
2015, we launched a direct-to-consumer insurance website that allows consumers to research health insurance trends, comparison
shop, and purchase IFP under the AgileHealthInsurance
®
brand. AgileHealthInsurance.com is one of the few internet
sites dedicated to helping consumers understand the benefits of Term Health Insurance. We use the term “Term Health Insurance”
to refer to health insurance products of less than one year in duration, such as STM. These new plans are the culmination of extensive
research on health insurance needs in the Patient Protection and Affordable Care Act (“PPACA”) era, and we believe
consumers will easily be able to find affordable prices for these plans on AgileHealthInsurance.com. AgileHealthInsurance.com
utilizes what we believe is a best-of-class plan comparison and online enrollment tool, to accompany these new plans. The underlying
technology was developed by engineers with decades of experience working on top-tier e-Commerce websites known for their ease-of-use.
Our
History
Our
business began operations as HPI in 2008. To facilitate the IPO, HII was incorporated in the State of Delaware in October 2012.
In November 2012, through a series of transactions, HPI assigned the operating assets of our business to HPIH, and HPIH assumed
the operating liabilities of HPI. Since November 2012, we have operated our business through HPIH and its subsidiaries.
Our
Reorganization and IPO
HII
was incorporated in the State of Delaware in October 2012 to facilitate the IPO and to become a holding company owning as its
principal asset membership interests in HPIH. Since November 2012, we have operated our business through HPIH and its consolidated
subsidiaries. See Note 7 for more information about the IPO.
HII
sold 4,666,667 shares of common stock for $14.00 per share in the IPO on February 13, 2013. Simultaneous with the offering, HII
obtained a 35% membership interest, 35% economic interest and 100% of the voting interest in HPIH.
Upon
completion of the offering, HII became a holding company the principal asset of which is its interest in HPIH. All of HII’s
business is conducted through HPIH and its subsidiaries. HII is the sole managing member of HPIH and has 100% of the voting rights
and control.
HII
has two classes of outstanding capital stock: Class A common stock and Class B common stock. Class A shares represent 100% of
the economic rights of the holders of all classes of our common stock to share in our distributions. Class B shares do not entitle
their holders to any dividends paid by, or rights upon liquidation of, HII. Shares of our Class A common stock vote together with
shares of our Class B common stock as a single class, except as otherwise required by law. Each share of our Class A common stock
and our Class B common stock entitles its holder to one vote. As of September 30, 2016, Michael Kosloske, our Executive Chairman
of the Board and Chief of Product Innovation, beneficially owns 47.1% of our outstanding Class A common stock and Class B common
stock on a combined basis, which equals his combined economic interest in the Company.
HPIH
has two series of outstanding equity: Series A Membership Interests, which may only be issued to HII, as sole managing member,
and Series B Membership Interests. The Series B Membership Interests are held by HPI and Health Plan Intermediaries Sub, LLC (“HPIS”),
a subsidiary of HPI, and these entities are beneficially owned by Mr. Kosloske. As of September 30, 2016, and December 31, 2015,
(i) the Series A Membership Interests held by HII represent 53.1% and 53.1%, respectively, of the outstanding membership interests,
53.1% and 53.1%, respectively, of the economic interests and 100% of the voting interests in HPIH and (ii) the Series B Membership
Interests held by the entities beneficially owned by Mr. Kosloske represent 46.9% and 46.9%, respectively, of the outstanding
membership interests, 46.9% and 46.9%, respectively, of the economic interests and no voting interest in HPIH.
Reclassifications
Certain
amounts in prior periods’ consolidated financial statements have been reclassified to conform to the current period presentation.
Such reclassifications include excluding amounts payable for third-party commission expense and third-party obligors payable from
restricted cash and including such amounts in cash and cash equivalents in the accompanying condensed consolidated statements
of cash flows.
Use
of Estimates
The
accompanying unaudited interim condensed consolidated financial statements of the Company include all normal recurring accruals
and adjustments considered necessary by management for their fair presentation in conformity with accounting principles generally
accepted in the United States of America (“GAAP”). Preparing financial statements in accordance with GAAP requires
management to make estimates, judgments 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 materially from those estimates. The consolidated results of operations
for the nine months ended September 30, 2016 are not necessarily indicative of results that may be expected for the year ending
December 31, 2016 or any future interim period.
Summary
of Significant Accounting Policies
The
following is an update to our significant accounting policies described in Note 1, Organization, Basis of Presentation, and Summary
of Significant Accounting Policies, in our audited consolidated financial statements for the year ended December 31, 2015 included
in our Annual Report on Form 10-K.
Restricted
Cash
In
our capacity as the policy administrator, we collect premiums from members and distributors and, after deducting our earned commission
and fees, remit these premiums to our contracted insurance carriers, discount benefit vendors and distributors. Where contractually
obligated, we hold the unremitted funds in a fiduciary capacity until they are disbursed, and the use of such funds is restricted.
We hold these funds in bank accounts. These unremitted amounts are reported as restricted cash in the accompanying condensed consolidated
balance sheets with the related liabilities reported in accounts payable. The Company previously referred to such restricted cash
as cash held on behalf of others.
The
Company also held restricted cash as pledged deposits with certain institutions. These deposits were contractually required and
were pledged as security for such institutions. At September 30, 2016, no such amounts were held restricted for this purpose.
No such amounts were restricted as of December 31, 2015.
Stock-based
Compensation
During
the second quarter of 2016, the company issued stock appreciation rights (“SARs”) that contain performance vesting
conditions. In accordance with GAAP, performance conditions that affect vesting are not reflected in estimating the fair value
of an award at the grant date and accruals of compensation cost for an award with a performance condition shall be based on the
probable outcome of that performance condition. Compensation cost shall be accrued if it is probable that the performance condition
will be achieved and shall not be accrued if it is not probable that the performance condition will be achieved. As such, management
must make certain judgements regarding the probability of achievement of certain targets defined within the respective SAR agreements
that may materially affect the timing of recognized compensation cost, if any at all.
Recent
Accounting Pronouncements
Following is a
summary of recent accounting pronouncements published by the Financial Accounting Standards Board (“FASB”). As noted
above, we have elected to delay the adoption of new and revised accounting pronouncements applicable to public companies until
such pronouncements are made applicable to private companies under provisions of the JOBS Act.
In August 2016, the FASB
issued an update to the presentation of certain cash receipts and cash payments as presented and classified in the statement of
cash flows. The update provides amendments to the codification for eight specific cash flow issues such as the classification
of debt prepayment or debt extinguishment costs to the classification of the proceeds from the settlement of insurance claims.
The amendments in this update are effective for public business entities for fiscal years beginning after December 15,
2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning
after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted,
including adoption in an interim period. We will adopt this guidance in reporting periods beginning after December 15, 2018. We
are currently evaluating the impact of this guidance on our condensed consolidated financial statements.
In March 2016, the FASB
issued an amendment to its accounting guidance for stock compensation as part of the FASB’s simplification initiative. The
amendments affect all entities that issue share-based payment awards to their employees. The areas for simplification involve
several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification
of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification
apply only to nonpublic entities. For public business entities, the amendments in this update are effective for annual
periods beginning after December 15, 2016, and interim periods within those annual periods. For all other entities, the amendments
are effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after
December 15, 2018. Early adoption is permitted for any entity in any interim or annual period. We will adopt this guidance in
reporting periods beginning after December 15, 2017. We are currently evaluating the impact of this guidance on our condensed
consolidated financial statements.
In February 2016, the
FASB issued an amendment to its accounting guidance for leases to increase transparency and comparability by requiring organizations
to recognize lease assets and lease liabilities on the balance sheet and increasing disclosures about key leasing arrangements.
The amendment updates the critical determinant from capital versus operating to whether a contract is or contains a lease because
lessees are required to recognize lease assets and lease liabilities for all leases – financing and operating – other
than short term. The amendments in this update are effective for public business entities for fiscal years beginning after
December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. We will adopt this guidance
in reporting periods beginning after December 15, 2018. The impact of adopting this pronouncement on our condensed consolidated
financial statements will be immaterial.
In May 2014, the FASB
issued an amendment to its accounting guidance related to revenue recognition. The amendment clarifies the principles for recognizing
revenue. The guidance is based on the principle that revenue is recognized to depict the transfer of goods or services to customers
in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising
from customer contracts, including significant judgments and changes in the judgments and assets recognized from costs incurred
to obtain or fulfill a contract. For a public entity, the amendments in this update are effective for annual reporting
periods beginning after December 15, 2016, including interim periods within that reporting period. For all other entities (nonpublic
entities), the amendments in this update are effective for annual reporting periods beginning after December 15, 2017,
and interim periods within annual periods beginning after December 15, 2018. Deferral of the Effective Date, defers the effective
date of this update by one year. Early adoption is not permitted. We will adopt this guidance in reporting periods beginning
after December 15, 2018. We are currently evaluating the impact of adopting this pronouncement on our condensed consolidated financial
statements.
2.
Variable Interest Entities
As
of September 30, 2016, we are the primary beneficiary of one entity, HPIH, that constitutes a VIE pursuant to FASB guidance. HPIH
is a VIE as the voting rights of the investors are not proportional to their obligations to absorb the expected losses of HPIH.
We hold 100% of the voting power in HPIH, but 53.1% of the total membership and economic interest, and the other members of HPIH
hold no voting rights in HPIH. Further, substantially all of the activities of HPIH are conducted on behalf of a membership with
disproportionately few voting rights. We have concluded that we are the primary beneficiary of HPIH, and, therefore, should consolidate
HPIH since we have power over and receive the benefits of HPIH. We have the power to direct the activities of HPIH that most significantly
impact its economic performance. Our equity interest in HPIH obligates us to absorb losses of HPIH and gives us the right to receive
benefits from HPIH related to the day-to-day operations of the entity, both of which could potentially be significant to HPIH.
As such, our maximum exposure to loss as a result of our involvement in this VIE is the net income or loss allocated to us based
on our interest.
On August 15, 2014, the
non-HII members of HPIH exchanged 1,725,000 Class B Membership Units of HPIH (together with an equal number of shares of HII Class
B common stock) in exchange for an equal number of Class A common stock pursuant to an Exchange Agreement (the “Exchange
Agreement”). See Note 7 for further information on the Exchange Agreement and this transaction. This transaction
resulted in HII obtaining greater than 50% of the membership and economic interest of HPIH. As of September 30, 2016, HII holds
100% of the voting power and 53.1% of the membership and economic interest in HPIH.
3.
Goodwill and Intangible Assets
Goodwill
Our
goodwill balance as of September 30, 2016 and December 31, 2015 of $41.1 million arose from previous acquisitions as described
in our Annual Report on Form 10-K for the year ended December 31, 2015. There have been no changes in the carrying amounts of
goodwill.
During
the second quarter of 2016, the Department of Health and Human Services issued a proposal to limit the duration of STM to a period
of no longer than three months compared to the current period of up to one year. The proposed rule led to a decline in stock price
which was deemed to be a triggering event for a goodwill impairment analysis and accordingly the Company performed step one of
the two step impairment test under GAAP. Upon completion of the step one analysis as of June 30, 2016, we determined that the
fair value of the reporting unit exceeded its carrying value. As such, a step two analysis was not required.
Other
intangible assets
Our
other intangible assets arose primarily from acquisitions described in our Annual Report on Form 10-K for the year ended December
31, 2015 and consist of a brand, our carrier network, distributor relationships, customer relationships, noncompete agreements
and capitalized software. Finite-lived intangible assets are amortized over their useful lives from two to fifteen years.
Major
classes of intangible assets as of September 30, 2016 consisted of the following ($ in thousands):
|
|
Weighted-average
Amortization (years)
|
|
|
Gross Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Intangible Assets, net
|
|
Brand
|
|
|
14.0
|
|
|
$
|
1,377
|
|
|
$
|
(289
|
)
|
|
$
|
1,088
|
|
Carrier network
|
|
|
5.0
|
|
|
|
40
|
|
|
|
(40
|
)
|
|
|
-
|
|
Distributor relationships
|
|
|
6.8
|
|
|
|
4,059
|
|
|
|
(2,682
|
)
|
|
|
1,377
|
|
Noncompete agreements
|
|
|
4.7
|
|
|
|
987
|
|
|
|
(835
|
)
|
|
|
152
|
|
Customer relationships
|
|
|
4.7
|
|
|
|
1,484
|
|
|
|
(1,118
|
)
|
|
|
366
|
|
Capitalized software
|
|
|
6.6
|
|
|
|
8,571
|
|
|
|
(3,135
|
)
|
|
|
5,436
|
|
Total intangible assets
|
|
|
|
|
|
$
|
16,518
|
|
|
$
|
(8,099
|
)
|
|
$
|
8,419
|
|
Major
classes of intangible assets as of December 31, 2015 consisted of the following ($ in thousands):
|
|
Weighted-average
Amortization (years)
|
|
|
Gross Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Intangible Assets, net
|
|
Brand
|
|
|
14.0
|
|
|
$
|
1,377
|
|
|
$
|
(219
|
)
|
|
$
|
1,158
|
|
Carrier network
|
|
|
5.0
|
|
|
|
40
|
|
|
|
(35
|
)
|
|
|
5
|
|
Distributor relationships
|
|
|
7.9
|
|
|
|
4,059
|
|
|
|
(2,234
|
)
|
|
|
1,825
|
|
Noncompete agreements
|
|
|
4.7
|
|
|
|
987
|
|
|
|
(679
|
)
|
|
|
308
|
|
Customer relationships
|
|
|
4.7
|
|
|
|
1,484
|
|
|
|
(1,019
|
)
|
|
|
465
|
|
Capitalized software
|
|
|
6.6
|
|
|
|
8,571
|
|
|
|
(2,271
|
)
|
|
|
6,300
|
|
Total intangible assets
|
|
|
|
|
|
$
|
16,518
|
|
|
$
|
(6,457
|
)
|
|
$
|
10,061
|
|
Amortization
expense for the three months ended September 30, 2016 and 2015 was $527,000 and $564,000, respectively, and for the nine months
ended September 30, 2016 and 2015 was $1.6 million and $1.5 million, respectively.
Estimated
annual pretax amortization of intangible assets for the remainder of 2016 and in each of the next five years and thereafter are
as follows ($ in thousands):
Remainder of 2016
|
|
$
|
512
|
|
2017
|
|
|
1,965
|
|
2018
|
|
|
1,725
|
|
2019
|
|
|
1,338
|
|
2020
|
|
|
1,338
|
|
2021
|
|
|
685
|
|
Thereafter
|
|
|
856
|
|
Total
|
|
$
|
8,419
|
|
4.
Accounts Payable and Other Liabilities
Accounts
payable and accrued expenses consisted of the following as of ($ in thousands):
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
Carriers and vendors payable
|
|
$
|
10,154
|
|
|
$
|
7,364
|
|
Commissions payable
|
|
|
2,992
|
|
|
|
3,830
|
|
Accrued wages
|
|
|
3,232
|
|
|
|
1,140
|
|
Accrued refunds
|
|
|
2,091
|
|
|
|
2,049
|
|
Accounts payable
|
|
|
881
|
|
|
|
670
|
|
Accrued professional fees
|
|
|
701
|
|
|
|
175
|
|
Accrued credit card/ACH fees
|
|
|
289
|
|
|
|
293
|
|
Accrued interest
|
|
|
8
|
|
|
|
3
|
|
Accrued restructuring
|
|
|
36
|
|
|
|
1,304
|
|
Other accrued expenses
|
|
|
867
|
|
|
|
1,019
|
|
Total accounts payable and accrued expenses
|
|
$
|
21,251
|
|
|
$
|
17,847
|
|
5.
Debt
Revolving
Line of Credit
On
December 15, 2014, we entered into a three-year revolving line of credit (“RLOC”) for $15.0 million with a bank. The
purpose of the RLOC is to provide working capital, expand the advanced commissions program, and to help us maintain adequate liquidity.
Borrowings under this facility are secured by all of our and our subsidiaries’ assets, including, but not limited to, cash,
accounts receivable, and property and equipment. The stated interest rate for the RLOC is 30-day LIBOR, plus 1.95%, which at September
30, 2016 and December 31, 2015 was 2.48% and 2.38%, respectively. As of September 30, 2016 we have drawn $5.0 million on the RLOC.
As of December 31, 2015, we had drawn $7.5 million on the RLOC. As of September 30, 2016 there is $10 million available to be
drawn upon the RLOC.
The
RLOC is subject to customary covenants and restrictions which, among other things, require us to maintain minimum working capital
equal to 1.50 times the outstanding balance, and require that our maximum funded debt to tangible net worth ratio shall not exceed
1.50 at any time during the term of the RLOC. The RLOC also imposes certain nonfinancial covenants on us that would require immediate
payment if we, among other things, reorganize, merge, consolidate, or otherwise change ownership or business structure without
the bank’s prior written consent. As collateral, there is a first position Uniform Commercial Code filing on all business
assets.
The
RLOC agreements also contain customary representations and warranties and events of default. The payment of outstanding principal
under the RLOC and accrued interest thereon may be accelerated and become immediately due and payable upon default of payment
or other performance obligations or failure to comply with financial or other covenants in the RLOC agreements, subject to applicable
notice requirements and cure periods as provided in the RLOC agreements. As of September 30, 2016 and December 31, 2015, the Company
was in compliance with all covenants of the RLOC agreement.
Under
the terms of the RLOC, we incurred certain costs related to acquiring the RLOC of $23,000. These costs have been capitalized and
are included in Accounts receivable, net, prepaid expenses and other current assets at September 30, 2016. As of September 30,
2016 and December 31, 2015, the balance of the deferred financing costs was $9,000 and $15,000, respectively. The deferred financing
costs consist primarily of consulting and legal fees directly related to the bank loan. These amounts are amortized over the life
of the related debt.
6.
Restructuring
During
the last quarter of the year ended December 31, 2015, the Company committed to and communicated a plan to restructure its operations
at ICE and Secured. The Company determined the services of ICE and Secured to be duplicative and recognized that efficiencies
could be gained by leveraging these operations with other owned call centers. As of December 31, 2015, the restructuring plan
was communicated to employees and substantially complete.
No
expense related to restructuring activities was recorded during the three and nine months ended September 30, 2016. As of September
30, 2016, the remaining liability associated with the restructuring is $36,000 and is included in the condensed consolidated balance
sheet as accounts payable and accrued expenses. At December 31, 2015, $1.3 million was included in the consolidated balance sheet
as accounts payable and accrued expenses.
All
liabilities associated with the restructuring approximate their fair values. All recorded liabilities are classified as current
within the condensed consolidated balance sheet.
7.
Stockholders’ Equity
On
February 13, 2013, we completed our IPO by issuing 4,666,667 shares of our Class A common stock, par value $0.001 per share, at
a price to the public of $14.00 per share of Class A common stock. In addition, we issued 8,666,667 shares of our Class B common
stock, of which 8,580,000 shares of Class B common stock were obtained by HPI, and 86,667 shares of Class B common stock were
obtained by Health Plan Intermediaries Sub, LLC (“HPIS”), of which HPI is the managing member. In addition, we granted
the underwriters of the IPO the right to purchase additional shares of Class A common stock to cover over-allotments (the “over-allotment
option”).
Our
authorized capital stock consists of 100,000,000 shares of Class A common stock, par value $0.001 per share, 20,000,000 shares
of Class B common stock, par value $0.001 per share, and 5,000,000 shares of preferred stock, par value $0.001 per share.
Class
A Common Stock and Class B Common Stock
Each
share of Class A common stock and Class B common stock entitles its holders to one vote per share on all matters to be voted upon
by the stockholders, and holders of each class will vote together as a single class on all such matters. Holders of shares of
our Class A common stock and Class B common stock vote together as a single class on all matters presented to our stockholders
for their vote or approval, except as otherwise required by applicable law. As of September 30, 2016, the Class A common stockholders
had 53.1% of the voting power in HII and the Class B common stockholders had 46.9% of the voting power in HII. Holders of shares
of our Class A common stock have 100% of the economic interest in HII. Holders of Class B common stock do not have an economic
interest in HII.
The
determination to pay dividends, if any, to our Class A common stockholders will be made by our Board of Directors. We do not,
however, expect to declare or pay any cash or other dividends in the foreseeable future on our Class A common stock, as we intend
to reinvest any cash flow generated by operations in our business. We may enter into credit agreements or other borrowing arrangements
in the future that prohibit or restrict our ability to declare or pay dividends on our Class A common stock. In the event of liquidation,
dissolution, or winding up of HII, the holders of Class A common stock are entitled to share ratably in all assets remaining after
payment of liabilities, subject to prior distribution rights of preferred stock, if any, then outstanding. The holders of our
Class A common stock have no preemptive or conversion rights or other subscription rights. There are no redemption or sinking
fund provisions applicable to the Class A common stock. The rights, preferences and privileges of holders of our common stock
will be subject to those of the holders of any shares of our preferred stock we may issue in the future.
Class
B common stockholders will not be entitled to any dividend payments. In the event of any dissolution, liquidation, or winding
up of our affairs, whether voluntary or involuntary, after payment of our debts and other liabilities and making provision for
any holders of our preferred stock that have a liquidation preference, our Class B common stockholders will not be entitled to
receive any of our assets. In the event of our merger or consolidation with or into another company in connection with which shares
of Class A common stock and Class B common stock (together with the related membership interests) are converted into, or become
exchangeable for, shares of stock, other securities or property (including cash), each Class B common stockholder will be entitled
to receive the same number of shares of stock as is received by Class A common stockholders for each share of Class A common stock,
and will not be entitled, for each share of Class B common stock, to receive other securities or property (including cash). No
holders of Class B common stock will have preemptive rights to purchase additional shares of Class B common stock.
The
following table presents the effects of changes in HII’s ownership interests in HPIH and its consolidated subsidiaries on
its equity ($ in 000’s):
|
|
Three Months Ended September
30,
|
|
|
Nine Months Ended September
30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Net income attributable to Health Insurance Innovations, Inc.
|
|
$
|
1,939
|
|
|
$
|
731
|
|
|
$
|
4,701
|
|
|
$
|
458
|
|
Contributions (distributions)
|
|
|
(3,460
|
)
|
|
|
(157
|
)
|
|
|
(3,528
|
)
|
|
|
(815
|
)
|
Total
|
|
$
|
(1,521
|
)
|
|
$
|
574
|
|
|
$
|
1,173
|
|
|
$
|
(357
|
)
|
Exchange
Agreement
On
February 13, 2013, we entered into an exchange agreement (the “Exchange Agreement”) with the holders of the Series
B Membership Interests of HPIH (“Series B Membership Interests”). Pursuant to and subject to the terms of the Exchange
Agreement and the amended and restated limited liability company agreement of HPIH, holders of Series B Membership Interests,
at any time and from time to time, may exchange one or more Series B Membership Interests, together with an equal number of shares
of our Class B common stock, for shares of our Class A common stock on a one-for-one basis, subject to equitable adjustments for
stock splits, stock dividends and reclassifications. See Note 1 from our December 31, 2015 audited consolidated financial statements
included in our Annual Report on Form 10-K for the year ended December 31, 2015 for further information on the Exchange Agreement.
Preferred
Stock
Our
board of directors has the authority to issue shares of preferred stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption,
redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series,
without further vote or action by the stockholders.
The
issuance of preferred stock may have the effect of delaying, deferring or preventing a change in control of HII without further
action by the stockholders and may adversely affect the voting and other rights of the holders of Class A common stock. At present,
we have no plans to issue any preferred stock.
Treasury
Stock
Treasury
stock is recorded at cost. As of September 30, 2016 and December 31, 2015, we held 165,588 and 150,993 shares of treasury stock,
respectively, recorded at a cost of $1.5 million and $1.5 million, respectively.
Share
Repurchase Program
On
December 17, 2014, our Board of Directors authorized us to purchase up to 800,000 shares of our registered Class A common stock
under a repurchase program which could remain in place until December 31, 2016. We have adopted a plan (the “Repurchase
Plan”) under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), in connection
with this authorization. The Repurchase Plan allows us to repurchase our shares of Class A common stock at times when we otherwise
might be prevented from doing so under insider trading laws or self-imposed trading blackout periods.
During
the three and nine months ended September 30, 2016 we made no repurchases under the Repurchase Plan. During the three months ended
September 30, 2015, we made no repurchases. During the nine months ended September 30, 2015, we repurchased 73,852 shares of our
registered Class A common stock under the Repurchase Plan at an average price per share of $7.05.
Tax
Obligation Settlements and Treasury Stock Transactions
Treasury
stock is recorded pursuant to the surrender of shares by certain employees to satisfy statutory tax withholding obligations on
vested restricted stock awards. In addition, certain forfeited stock-based awards are transferred to and recorded as treasury
stock, and certain restricted stock awards have been granted from shares in Treasury, and certain forfeited awards.
During
the three and nine months ended September 30, 2016, 7,528 and 14,059 shares, respectively, were transferred to Treasury as a result
of surrendered shares of vested restricted stock awards and 1,200 and 16,480 options, respectively, were exercised and converted
to Class A common stock out of treasury. During the three and nine months ended September 30, 2016, 40,400 and 43,600 shares,
respectively, were transferred to Treasury as a result of forfeitures of restricted stock awards. During the three and nine months
ended September 30, 2015, zero and 15,790 shares, respectively, were transferred to Treasury as a result of surrendered shares
of vested restricted stock awards, 7,500 and 164,132 shares, respectively, were transferred to Treasury as the result of forfeitures
of restricted stock awards. During the three and nine months ended September 30, 2015, 70,000 and 151,216 Treasury shares were
granted under restricted stock awards, respectively.
8.
Stock-based Compensation
We
maintain one stock-based incentive plan, the Health Insurance Innovations, Inc. Long Term Incentive Plan (the “LTIP”),
which became effective February 7, 2013, under which SARs, restricted stock, restricted stock units and other types of equity
and cash incentive awards may be granted to employees, non-employee directors and service providers. The LTIP expires after ten
years, unless prior to that date the maximum number of shares available for issuance under the plan has been issued or our Board
of Directors terminates this plan. At its inception, 1,250,000 shares of Class A common stock were reserved for issuance under
the LTIP. In May 2016, the Company’s shareholders approved an increase of 1,000,000 shares of Class A common stock and as
of that date, there were 3,250,000 shares of Class A common stock reserved for issuance under the LTIP. As of December 31, 2015,
there were 2,250,000 shares of Class A common stock reserved for issuance under the LTIP.
Expense
for stock-based compensation is recognized based upon estimated grant date fair value and is amortized over the requisite service
period of the awards using the accelerated method. We offer awards which vest based on service conditions, performance conditions,
or market conditions. For grants of SARs and stock options, we apply the Black-Scholes option-pricing model, a Monte Carlo Simulation,
or a lattice model, depending on the vesting conditions, in determining the fair value of share-based payments to employees. These
models incorporate various assumptions, including expected volatility and expected term. Through November of 2015, expected stock
price volatilities were estimated using implied volatilities of comparable publicly-traded companies, given our limited trading
history. As of December 2015, volatility is calculated using the Company’s trading history. The expected term of the awards
represents the estimated period of time until exercise, giving consideration to the contractual terms, vesting schedules and expectations
of future employee behavior. The Company uses its best estimate and the simplified method for “plain vanilla” awards
under GAAP for calculating the expected term, where applicable. The risk-free interest rate is based on the U.S. Treasury yield
curve in effect at the time of grant with an equivalent remaining term. Compensation expense is recognized only for those awards
expected to vest, with forfeitures estimated based on our historical experience and future expectations. In accordance with GAAP,
compensation expense is not recognized for awards with performance vesting conditions until it is deemed probable that the underlying
performance events will occur. All stock-based compensation expense is classified within S, G & A expense in the condensed
consolidated statements of operations.
None
of the stock-based compensation was capitalized during the three and nine months ended September 30, 2016 and 2015, respectively.
The
Black-Scholes option-pricing model was used with the following weighted average assumptions:
|
|
Nine Months Ended September
30,
|
|
|
|
2016
|
|
|
2015
|
|
Risk-free rate
|
|
|
1.2
|
%
|
|
|
1.5
|
%
|
Expected life
|
|
|
4.6
|
|
|
|
4.6
|
|
Expected volatility
|
|
|
56.5
|
%
|
|
|
44.3
|
%
|
Expected dividend
|
|
|
none
|
|
|
|
none
|
|
The
following table summarizes restricted shares, SARs, and stock options granted during the three and nine months ended September
30, 2016 and 2015 (in thousands):
|
|
Three Months Ended September
30,
|
|
|
Nine Months Ended September
30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Restricted shares
|
|
|
28
|
|
|
|
70
|
|
|
|
54
|
|
|
|
161
|
|
SARs
|
|
|
104
|
|
|
|
325
|
|
|
|
703
|
|
|
|
720
|
|
Stock options
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
There
were no exercises of SARs during the three and nine months ended September 30, 2016. During the three and nine months ended September
30, 2016, 2,250 and 24,250 SARs, respectively, and 30,400 and 43,600 restricted share awards, respectively, were forfeited. During
the three and nine months ended September 30, 2015, 75,000 and 301,000 SARs, respectively, and 7,500 and 164,132 restricted share
awards, respectively, were forfeited. All of these awards were unvested. No SARs were exercised during the three and nine months
ended September 30, 2015.
During
the three and nine months ended September 30, 2016, there were 1,200 and 16,480 options exercised, respectively. During the three
and nine months ended September 30, 2015, there were no options exercised.
For
the three and nine months ended September 30, 2016, the settlement of stock based incentive plans resulted in a cash outflow of
$36,000 and $75,000, respectively, with respect to shares redeemed to cover the recipient’s tax obligations. For the three
and nine months ended September 30, 2015, these settlements resulted in a cash outflow of $0 and $89,000, respectively. We recognized
an income tax benefit of $10,000 and $52,000 from stock-based activity for the three and nine months ended September 30, 2016,
respectively, and $0 and $91,000 for the three and nine months ended September 30, 2015, respectively.
The
following table summarizes stock-based compensation expense for the three and nine months ended September 30, 2016 and 2015 ($
in thousands):
|
|
Three Months Ended September
30,
|
|
|
Nine Months Ended September
30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Restricted shares
|
|
$
|
(41
|
)
|
|
$
|
85
|
|
|
$
|
254
|
|
|
$
|
349
|
|
SARs
|
|
|
415
|
|
|
|
188
|
|
|
|
1,019
|
|
|
|
384
|
|
Stock options
|
|
|
19
|
|
|
|
41
|
|
|
|
89
|
|
|
|
268
|
|
|
|
$
|
393
|
|
|
$
|
314
|
|
|
$
|
1,362
|
|
|
$
|
1,001
|
|
The
following table summarizes unrecognized stock-based compensation and the remaining weighted average period over which such stock-based
compensation is expected to be recognized as of September 30, 2016 ($ in thousands):
|
|
|
|
|
Weighted
Average
Remaining
years
|
|
Restricted shares
|
|
$
|
469
|
|
|
|
1.5
|
|
SARs
|
|
|
2,239
|
|
|
|
1.7
|
|
Stock
options
|
|
|
23
|
|
|
|
0.7
|
|
|
|
$
|
2,731
|
|
|
|
|
|
The
amounts in the table above do not include the cost of any additional awards that may be granted in future periods nor any changes
in our forfeiture rate.
9.
Net Income per Share
The
computations of basic and diluted net income (loss) per share attributable to HII for the three and nine months ended September
30, 2016 and 2015 were as follows ($ in thousands, except share and per share data):
|
|
Three Months Ended September
30,
|
|
|
Nine Months Ended September
30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Basic net income attributable to Health Insurance Innovations, Inc.
|
|
$
|
1,939
|
|
|
$
|
731
|
|
|
$
|
4,701
|
|
|
$
|
458
|
|
Average shares—basic
|
|
|
7,614,252
|
|
|
|
7,531,827
|
|
|
|
7,590,347
|
|
|
|
7,521,124
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted shares
|
|
|
67,798
|
|
|
|
19,413
|
|
|
|
87,155
|
|
|
|
72,815
|
|
SARs
|
|
|
—
|
|
|
|
—
|
|
|
|
5,226
|
|
|
|
2,931
|
|
Stock options
|
|
|
41,146
|
|
|
|
20,224
|
|
|
|
41,440
|
|
|
|
16,563
|
|
Average shares—diluted
|
|
|
7,723,196
|
|
|
|
7,571,464
|
|
|
|
7,724,168
|
|
|
|
7,613,433
|
|
Basic net income per share attributable to Health Insurance Innovations, Inc.
|
|
$
|
0.25
|
|
|
$
|
0.10
|
|
|
$
|
0.62
|
|
|
$
|
0.06
|
|
Diluted net income per share attributable to Health Insurance Innovations, Inc.
|
|
$
|
0.25
|
|
|
$
|
0.10
|
|
|
$
|
0.61
|
|
|
$
|
0.06
|
|
Potential
common shares are included in the diluted per share calculation when dilutive. Potential common shares consist of Class A common
stock issuable through unvested restricted stock grants and stock appreciation rights and are calculated using the treasury stock
method.
The
following securities were not included in the calculation of diluted net income (loss) per share because such inclusion would
be anti-dilutive (in thousands):
|
|
Three Months Ended September
30,
|
|
|
Nine Months Ended September
30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Restricted shares
|
|
|
31
|
|
|
|
44
|
|
|
|
42
|
|
|
|
70
|
|
SARs
|
|
|
131
|
|
|
|
113
|
|
|
|
88
|
|
|
|
129
|
|
Stock options
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Additionally, potential
common stock totaling 6,841,667 shares at September 30, 2016 and 2015 issuable under an exchange agreement were not included in
diluted shares because such inclusion would be antidilutive. See Note 7 for further details on the exchange agreement.
10.
Income Taxes
HPIH
is taxed as a partnership for income tax purposes; as a result, it is not subject to entity-level federal or state income taxation
but its members are liable for taxes with respect to their allocable shares of each company’s respective net taxable income.
We are subject to U.S. corporate federal, state and local income taxes on our allocable share of net taxable income that is reflected
in our consolidated financial statements.
The
effective tax rate for the three and nine months ended September 30, 2016 was 23.4% and 17.6%, respectively. The effective tax
rate for the three and nine months ended September 30, 2015 was (85.7%) and (115.9%), respectively. For the three and nine months
ended September 30, 2016, the provision for income taxes was $1.6 million and $2.5 million, respectively. For the three and nine
months ended September 30, 2015, the benefit for income taxes was $701,000 and $664,000, respectively. Deferred taxes on our investment
in HPIH are measured on the difference between the carrying amount of our investment in HPIH and the corresponding tax basis of
this investment. We do not measure deferred taxes on differences within HPIH, as those differences inherently comprise our deferred
taxes on our external investment in HPIH.
Our
effective tax rate includes a rate detriment attributable to the fact that certain of our subsidiaries operate as limited liability
companies which are not subject to federal or state income tax. Accordingly, a portion of our earnings or losses attributable
to noncontrolling interests are not subject to corporate level taxes. Additionally, our effective tax rate includes a valuation
allowance placed on all of our net deferred tax assets, as our belief is more likely than not that some of our deferred tax assets
will not be realized to offset future taxable income.
We recorded a valuation
allowance against all of the deferred tax assets of HII as of both September 30, 2016, and December 31, 2015. We intend to continue
maintaining a full valuation allowance on all of the deferred tax assets of HII until there is sufficient evidence to support
the reversal of all or some portion of this allowance. Should we determine that we would be able to realize our remaining deferred
income tax assets in the foreseeable future, a release of all, or part, of the related valuation allowance would result in the
recognition of certain deferred tax assets in the period such determination is made. Significant management judgment is required
in determining the period in which the reversal of a valuation allowance should occur. We consider all available evidence, both
positive and negative, such as historical levels of income and future forecasts of taxable income, among other items, in determining
whether a full or partial release of a valuation allowance is required. In addition, our assessments sometimes require us to schedule
future taxable income in accordance with the applicable tax accounting guidance to assess the appropriateness of a valuation allowance
which further requires the exercise of significant management judgment. Such release of the valuation allowance could occur within
the next 12 months upon resolution of the aforementioned uncertainties. A reduction of the valuation allowance would also result
in the recognition of a tax receivable agreement obligation. See Note 11 for further information.
We
account for uncertainty in income taxes using a two-step process. The first step is to evaluate the tax position for recognition
by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained
upon audit, including resolution of related appeals or litigation processes, if any. The second step requires us to estimate and
measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. Such amounts
are subjective, as a determination must be made on the probability of various possible outcomes. We reevaluate uncertain tax positions
on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes
in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition and measurement could
result in recognition of a tax benefit or an additional tax provision.
For
the three and nine months ended September 30, 2016 and 2015, respectively, we did not have a balance of gross unrecognized tax
benefits, and as such, no amount would favorably affect the effective income tax rate in any future periods. We believe that there
will not be a significant increase or decrease to the uncertain tax positions within 12 months of the reporting date. The Company
accounts for interest and penalties associated with uncertain tax positions as a component of tax expense, and none were included
in the Company’s financial statements as there are not uncertain tax positions outstanding as of September 30, 2016 and
2015, respectively. The Company’s 2012 through 2015 tax years remain subject to examination by tax authorities.
11.
Commitments and Contingencies
BimSym
Agreements
On
August 1, 2012, we entered into a software assignment agreement with BimSym eBusiness Solutions, Inc. (“BimSym”) for
our exclusive ownership of all rights, title and interest in the technology platform (“A.R.I.E.S. System”) developed
by BimSym and utilized by us. As a result of the agreement, we purchased the A.R.I.E.S. System, our proprietary sales and member
administration platforms, for $45,000 and this purchase was capitalized and recorded as an intangible asset. In connection with
this agreement, we simultaneously entered into a master services agreement for the technology, under which we are required to
make monthly payments of $26,000 for 5 years. After the five-year term, this agreement automatically renews for one-year terms
unless we give 60 days’ notice.
Additionally,
we also entered into an exclusivity agreement with BimSym whereby neither BimSym nor any of its affiliates will create, market
or sell a software, system or service with the same or similar functionality as that of the A.R.I.E.S. System under which we are
required to make monthly payments of $16,000 for five years. The present value of these payments was capitalized and recorded
as an intangible asset with a corresponding liability on the accompanying condensed consolidated balance sheets.
Tax
Receivable Agreement
On
February 13, 2013, we entered into a Tax Receivable Agreement (“TRA”) with the holders of the HPIH Series B Membership
Interests, which holders are beneficially owned by Michael W. Kosloske, our founder, Executive Chairman of the Board, and Chief
of Product Innovation. The TRA requires us to pay to such holders 85% of the cash savings, if any, in U.S. federal, state and
local income tax we realize (or are deemed to realize in the case of an early termination payment, a change in control or a material
breach by us of our obligations under the TRA) as a result of any possible future increases in tax basis and of certain other
tax benefits related to entering into the TRA, including tax benefits attributable to payments under the TRA itself. This is HII’s
obligation and not an obligation of HPIH. HII will benefit from the remaining 15% of any realized cash savings. For purposes of
the TRA, cash savings in income tax is computed by comparing our actual income tax liability with our hypothetical liability had
we not been able to utilize the tax benefits subject to the TRA itself. The TRA became effective upon completion of the IPO and
will remain in effect until all such tax benefits have been used or expired, unless HII exercises its right to terminate the TRA
for an amount based on the agreed payments remaining to be made under the agreement or HII breaches any of its material obligations
under the TRA in which case all obligations will generally be accelerated and due as if HII had exercised its right to terminate
the agreement. Any potential future payments will be calculated using the market value of our Class A common stock at the time
of the relevant exchange and prevailing tax rates in future years and will be dependent on us generating sufficient future taxable
income to realize the benefit. Payments are generally due under the TRA within a specified period of time following the filing
of our tax return for the taxable year with respect to which payment of the obligation arises.
Exchanges
of Series B Membership Interests, together with an equal number of shares of our Class B common stock, for shares of our Class A
common stock, are expected to increase our tax basis in our share of HPIH’s tangible and intangible assets. These increases
in tax basis are expected to increase our depreciation and amortization deductions and create other tax benefits and therefore
may reduce the amount of tax that we would otherwise be required to pay in the future. As of September 30, 2016, Series B Membership
Interests, together with an equal number of shares of Class B common stock have been exchanged for
of
a total of 1,825,000 shares of Class A common stock subsequent to the IPO. See Note 7 for further information on these
issuances of Class A common stock. As a result of the exchanges noted above, we have recorded a liability of $1.2 million
pursuant to the TRA as of September 30, 2016. We have determined that some of this amount is probable to be paid, because a portion
of the deductions and other tax benefits noted above has been utilized based on our estimated taxable income for 2016. Therefore
we have also reversed a portion of the valuation allowance on our deferred tax assets related to the tax receivable agreement.
The exchange transactions created a tax benefit to be shared by the Company and the entities beneficially owned by Mr. Kosloske.
Our total liability pursuant to the tax receivable agreement for exchange transactions completed through September 30, 2016 would
be $10.7 million, representing the share of tax benefits payable to the entities beneficially owned by Mr. Kosloske, if we generate
sufficient taxable income in the future. We have made no payments under the tax receivable agreement as of September 30, 2016,
but plan to make payments of $444,000 under the tax receivable agreement during the year ended December 31, 2016.
Distributor
Advanced Commissions
As
a course of business, we enter into agreements with our distributors to loan future commission payments based on actual sales,
referred to as advanced commissions, net on the condensed consolidated balance sheets. Certain of these agreements may include
a loan agreement and a UCC1 financing statement for the purposes of securing the future commission payments we make. Generally,
these loans will be repaid to us by future commissions earned by the distributor based on actual sales, as described in the respective
agreements. The Company makes an allowance for uncollectible advanced commissions based on an assessment of recoverability. Allowances
are applied to advance commissions when events or circumstances indicate that the carrying amount may not be recoverable. While
the Company does not expect to continue the same degree of historic expansion with the advanced commissions program, the Company
is evaluating alternative sources of funding to complement the program should additional growth be appropriate.
On
May 1, 2015, we entered into an agreement with Health Benefits One (“HBO”), and certain individuals and entities related
to HBO to make advances via a variable secured promissory note (the “May 2015 Note”). The May 2015 Note provides for
two advances of $500,000 each. As of December 31, 2015, the Company paid both advances totaling $1.0 million. The May 2015 Note,
which secures the advances, matures on January 31, 2017 and bears interest only upon the occurrence of an event of default. All
amounts outstanding, including interest, are due within thirty days of the maturity date, subject to acceleration upon the occurrence
of an event of default.
Under
the May 2015 Note, HBO was eligible to earn production credits, beginning in January 2016, for each qualifying sale of our products,
as defined in the May 2015 Note. Such production credits would be applied based on qualifying sales during each calendar quarter
of 2016. Any such production credits earned during calendar year 2016 would be applied against the outstanding balance payable
to us under the May 2015 Note in lieu of a cash payment to us but no amount would be payable by us to HBO. There was no remaining
balance under the May 2015 Note at September 30, 2016.
Legal
Proceedings
The
Company is subject to legal proceedings, claims, and liabilities that arise in the ordinary course of business. The Company accrues
losses associated with legal claims when such losses are probable and reasonably estimable. If the Company determines that a loss
is probable and cannot estimate a specific amount for that loss, but can estimate a range of loss, the best estimate within the
range is accrued. If no amount within the range is a better estimate than any other, the minimum amount of the range is accrued.
Estimates are adjusted as additional information becomes available or circumstances change. Legal defense costs associated with
loss contingencies are expensed in the period incurred.
State
Regulatory Examinations
The Company has received
notification from the Indiana Department of Insurance that a multistate examination has been commenced providing for the review
of HCC Life Insurance Company’s (“HCC”) short term medical plans, Affordable Care Act compliance, marketing,
and rate and form filing for all products. As the Company is a distributor of HCC products, the notification indicated that the
multistate examination will include a review of the activities of the Company and a review of whether the Company’s practices
are in compliance with Indiana insurance law and the similar laws of other states participating in the examination. The Indiana
Department of Insurance will serve as the managing participant of the multistate examination, and the examination will include,
among other things, a review of whether HCC (and presumably the Company) has engaged in any unfair or deceptive acts or insurance
business practices. In addition to the multistate examination led by Indiana, we are aware that several other states, including
Arkansas, Florida, Kansas, Montana, Ohio, South Dakota, Texas and Massachusetts, are reviewing the sales practices and
potential unlicensed sale of insurance by third-party distributor call centers utilized by the Company. The Company is not aware
of any examination into the sales practices of the Company-owned call centers, although the Company cannot be certain that no
such investigation is occurring or will occur, and the Company is aware of and managing additional claims and inquiries that it
does not believe are material at this time. It is too early to determine whether any of these regulatory examinations will have
a material impact on the Company. The Company is proactively communicating and cooperating with all applicable regulatory agencies.
Montana
Regulatory Action
The
Company has also received notification from the Office of the Montana State Auditor, Commissioner of Securities and Insurance
(“CSI”) that an administrative action has been initiated against it. The Company was among more than two dozen separate
parties named by the CSI in a Notice of Proposed Agency Action on May 12, 2016, that alleges potential violations of the Montana
Insurance Code. The Notice, directed to the Company as well as a large pool of third-party respondents ranging from very large
companies to individual insurance agents, indicated that the CSI was concerned with the possibility of unfair trade practices,
potentially unlicensed insurance practices, or agents that were not properly appointed to the insurance carriers for whom products
were being offered. Seventeen of the named parties, including the Company, have requested a hearing before the CSI to contest
the state’s allegations and the Company is in the process of retrieving data and information to do so. The state has formally
granted the Company’s request to be heard on the issues, and a neutral Hearing Officer experienced in the insurance industry,
has been appointed to hear the matter. This matter is at a very early stage of the investigative process and the Company has been
cooperative with the CSI while seeking to properly measure and gauge the potential of the allegations.
While
it is still too early to assess whether the CSI’s Notice and the investigation of these organizations and individuals will
have a material impact on the Company, the Company believes that based on nature of the allegations and evidence provided by the
state of Montana during the third quarter, a loss arising from the future assessment of a civil penalty against the Company is
probable. Notwithstanding, the Company is currently unable to either estimate the amount of any potential civil penalty, or determine
a range of potential loss, as the Company lacks insight into the events or factors that could assist the Company in estimating
the amount of any potential civil penalty or a range of potential loss related to such penalties. It is very possible that there
may be no financial loss, or a reasonable resolution reached with the CSI. The Company continues to regularly communicate and
work closely with the CSI in furtherance of bringing the matter towards a mutually satisfactory resolution.
12.
Fair Value Measurements
We
measure and report financial assets and liabilities at fair value on a recurring basis. Fair value is defined as the exchange
price that would be received for an asset or paid to transfer a liability (referred to as an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable
inputs. The fair value of our financial assets and liabilities is determined by using three levels of input, which are defined
as follows:
|
Level
1:
|
Quoted
prices in active markets for identical assets or liabilities
|
|
|
|
|
Level
2:
|
Quoted
prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in
markets that are not active, or inputs other than quoted prices that are observable for the asset or liability
|
|
|
|
|
Level
3:
|
Unobservable
inputs for the asset or liability
|
The
categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant
to the fair value measurement.
We
utilize the market approach to measure the fair value of our financial assets. As subjectivity exists with respect to many of
the valuation techniques, the fair value estimates we have disclosed may not equal prices that we may ultimately realize if the
assets are sold or the liabilities are settled with third parties. Below is a description of our valuation methods.
Contingent
consideration for business acquisition.
The contingent consideration related to the acquisition of Secured and ASIA includes
periodic cash payments, as described in Note 2 in our audited consolidated financial statements for the year ended December 31,
2015 included in our Annual Report on Form 10-K, and were valued using external valuation specialists. The inputs include discount
rates reflecting the credit risk, and the probability of the underlying outcome of the results required by Secured to receive
payment and the nature of such payments. The underlying outcomes are subject to the target results in the respective instruments
or agreement. These liabilities are included in Level 3 of the fair value hierarchy.
Noncompete obligation.
Our noncompete obligation, an exclusivity agreement with the developer of the A.R.I.E.S System as described in Note 11 is
primarily valued using nonbinding market prices as stated in the agreement that are corroborated by observable market data. The
inputs and fair value are reviewed for reasonableness and may be further validated by comparison to publicly available information
or compared to multiple independent valuation sources. The noncompete obligation is classified within Level 2 of the fair value
hierarchy.
The
carrying amounts of financial assets and liabilities reported in the accompanying condensed consolidated balance sheets for cash
and cash equivalents, restricted cash, credit card transactions receivable, accounts receivable, advanced commissions, carriers
and vendors payable, commissions payable, line of credit, and accounts payable and accrued expenses as of September 30, 2016 and
December 31, 2015, respectively, approximate fair value because of the short-term duration of these instruments.
As
of September 30, 2016, our liabilities measured at fair value were as follows ($ in thousands):
|
|
Carrying Value as of
|
|
|
Fair Value Measurement
as of September 30, 2016
|
|
|
|
September 30, 2016
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncompete obligation
|
|
$
|
156
|
|
|
$
|
—
|
|
|
$
|
156
|
|
|
$
|
—
|
|
Contingent acquisition consideration
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
$
|
156
|
|
|
$
|
—
|
|
|
$
|
156
|
|
|
$
|
—
|
|
As
of December 31, 2015, our liabilities measured at fair value were as follows ($ in thousands):
|
|
Carrying Value as of
|
|
|
Fair Value Measurement
as of December 31, 2015
|
|
|
|
December 31, 2015
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncompete obligation
|
|
$
|
291
|
|
|
$
|
—
|
|
|
$
|
291
|
|
|
$
|
—
|
|
Contingent acquisition consideration
|
|
|
532
|
|
|
|
—
|
|
|
|
—
|
|
|
|
532
|
|
|
|
$
|
823
|
|
|
$
|
—
|
|
|
$
|
291
|
|
|
$
|
532
|
|
A
summary of the changes in the fair value of liabilities carried at fair value that have been classified in Level 3 of the fair
value hierarchy was as follows ($ in thousands):
|
|
Contingent Acquisition
Consideration
|
|
Balance as of January 1, 2015
|
|
$
|
4,400
|
|
Issuance and settlements, net
|
|
|
(2,603
|
)
|
Realized gain included in income
|
|
|
(1,265
|
)
|
Balance as of December 31, 2015
|
|
$
|
532
|
|
Issuance and settlements, net
|
|
|
(532
|
)
|
Realized gain included in income
|
|
|
—
|
|
Balance as of September 30, 2016
|
|
$
|
—
|
|
Realized
and unrealized loss on the contingent acquisition consideration are included in fair value adjustment of contingent consideration
on the accompanying condensed consolidated statements of operations.
13.
Segment Information
Operating
segments are defined as components of an enterprise about which separate financial information is available that is evaluated
regularly by the chief operating decision maker (“CODM”), or decision-making group, in deciding how to allocate resources
and in assessing performance. During the three months ended March 31, 2015, we had two reportable segments: IPD and HP; however
during the three months ended June 30, 2015, the structure of our organization changed such that our President and Chief Executive
Officer became our named CODM. HP is viewed by our CODM as a component of the operations comprising the IPD segment. The CODM
reviews our financial information in a manner substantially similar to the accompanying consolidated financial statements. As
such, at September 30, 2016 and December 31, 2015, we had one reportable operating and geographic segment.
14.
Related Party Transactions
Health
Plan Intermediaries, LLC
HPI and its subsidiary
HPIS, which are beneficially owned by Mr. Kosloske, are related parties by virtue of their Series B Membership Interests
in HPIH, of which we are managing member. During the nine months ended September 30, 2016 and 2015, HPIH paid cash distributions
of $86,000 and $657,000, respectively, for these entities related to estimated federal and state income taxes, pursuant to the
operating agreement of HPIH entered into by HPIH, HII and HPI.
Distributions
by HPIH to its members
Pursuant to the operating
agreement of HPIH, we determine when distributions will be made to the members of HPIH and the amount of any such distributions,
except that HPIH is required by the operating agreement to make certain pro rata distributions to each member of HPIH quarterly
on the basis of the assumed tax liabilities of the members.
Members of HPIH, including
HII, incur U.S. federal and state income taxes on their allocable share of any net taxable income of HPIH. Net profits
and net losses of HPIH are generally allocated to its members pro rata in accordance with the percentage interest of the units
they hold. In accordance with the operating agreement of HPIH, we cause HPIH to make cash distributions to its members
for purposes of funding their tax obligations in respect of the income of HPIH that is allocated to them. Generally, these tax
distributions are computed based on our estimate of the net taxable income of HPIH allocable to the member multiplied by an assumed
tax rate equal to the highest marginal effective federal, state and local income tax rate applicable for an individual or corporation
taking into account any allowable deductions. Additional amounts may be distributed to us if needed to meet our tax obligations
and our obligations pursuant to the TRA.
We
are not permitted to cause HPIH to make distributions that would render it insolvent. All distributions from HPIH are made to
the members of HPIH pro rata in accordance with the percentage economic interest of the units they hold.
As
of September 30, 2016, $3.4 million is included in Due to member as a current liability on the condensed consolidated balance
sheet for member distributions declared but not yet paid.
Tax
Receivable Agreement
As discussed in Note 11,
on February 13, 2013, we entered into a tax receivable agreement with the holders of the HPIH Series B Membership Interests,
which holders are beneficially owned by Mr. Kosloske.
As
of September 30, 2016, we have made no such payments under the TRA but plan to make payments of $444,000 under the tax receivable
agreement during the year ended December 31, 2016. As of September 30, 2016, we would be obligated to pay $1.2 million pursuant
to the TRA, of which $845,000 is included in current liabilities and $361,000 is included in long-term liabilities on the accompanying
condensed consolidated balance sheets. As of December 31, 2015, $748,000 was payable pursuant to the TRA, of which $342,000 was
included in current liabilities and $406,000 was included in long-term liabilities on the accompanying condensed consolidated
balance sheets. Our total liability pursuant to the TRA for exchange transactions completed through September 30, 2016 would be
$10.7 million if we generate sufficient taxable income in the future.
Reinsurance
Insurance
carriers with which we do business often reinsure a portion of their risk. From time to time, entities owned or affiliated with
Michael Kosloske, serve as reinsurers for insurance carriers that offer products sold by HPIH.
15.
Subsequent Events
On June 10, 2016, the
Internal Revenue Service, the Employee Benefits Security Administration, and the U.S Department of Health and Human Services,
collectively “HHS,” proposed rule 2016-13583, that impacts STM insurance. On October 31, 2016, HHS published
the rule substantially as proposed which limits STM duration to periods of less than three months including any period for which
the policy may be renewed. The rule also requires notification of non-compliance with the minimum essential coverage standards
set forth in the Affordable Care Act. The rule goes into effect on January 1, 2017 however neither HHS nor the states will enforce
the rule regarding duration or renewal of STM plans until April 1, 2017. This rule will likely have a material impact on revenues
generated from the sale of STM products beginning with our 2017 fiscal year but we are not yet able to determine the impact on
total revenues, if any, as we will seek to mitigate revenue losses, if any, by offering new products, by growing our already strong
distribution channels and by continuing our direct-to-consumer emphasis while simultaneously increasing operating leverage.
On
October 1, 2016, the Company came to mutual agreement with HCC Life Insurance Company (“HCC”), a third-party insurance
carrier, to modify the terms of our carrier contract. The Company no longer sells new HCC STM products through our third-party
distributors. We continue to write new HCC products through our company owned call center and AgileHealthInsurance.com. We do
not expect this contract modification to have a material impact, if any, on our company revenues.