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 term “HIIQ” refers to Health Insurance Innovations, Inc. on a stand-alone basis, and the term “HPIH” refers to Health Plan Intermediaries Holdings, LLC, a subsidiary of HIIQ and a consolidated subsidiary of the Company, on a stand-alone basis. The terms “HealthPocket” or “HP” refer to HealthPocket, Inc., our wholly owned subsidiary which was acquired by HPIH on July 14, 2014.
Business Description
We are a developer, distributor, and cloud-based administrator of affordable individual and family health insurance plans (“IFP”) which include short-term medical (“STM”) insurance plans and guaranteed-issue and underwritten Health Benefit Insurance Plans ("HBIP"), previously referred to as hospital indemnity plans.
We also develop, distribute and administer supplemental products which include 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 IFPs and supplemental products on behalf of insurance carriers and discount benefit providers. These products are marketed to individuals primarily through our internal distribution network and an external distribution network consisting primarily of independently owned and operated licensed-agent call centers. We are not an insurer and do not process or pay claims. The health insurance products we develop are underwritten by insurance carriers, and we assume no underwriting, insurance or reimbursement risk.
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 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. See Note 2 for further information on the VIE. All significant intercompany balances and transactions have been eliminated in preparing the condensed 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 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, 2016
. The condensed consolidated results for th
e
three and nine months ended
September 30, 2017
are not necessarily indicative of the results to be expected for any interim subsequent period or for the year ending
December 31, 2017
.
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. Under the JOBS Act, we have also elected 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 until the last day of the
fifth
year following the year of completion of our IPO which closed on February 13, 2013. However, if we record
$1.07 billion
in total annual gross
revenue before that time or 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.
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, 2016
included in our Annual Report on Form 10-K.
Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements. These estimates also affect the reported amounts of revenues and expenses during the reporting periods. Actual results could materially differ from those estimates.
Recent Accounting Pronouncements
In the following summary of recent accounting pronouncements, all references to effective dates of Financial Accounting Standards Board (“FASB”) guidance relate to nonpublic entities. 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 the provisions of the JOBS Act.
Recently adopted accounting pronouncements
In March 2016, the FASB issued an amendment to its accounting guidance for stock compensation as part of the FASB’s simplification initiative. The amendment affects 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.
The Company elected to early adopt this update during the quarter ended March 31, 2017. As described in Note 19 in our Annual Report on Form 10-K for the year ended December 31, 2016, the Company’s former Chief Executive Officer exercised
1.0 million
Stock Appreciation Rights in February 2017. Early adoption of this update was favorable in light of the material exercise and as a result of this adoption, during the three months ended March 31, 2017, excess tax benefits of
$3.3 million
related to vested and exercised share-based compensation awards were recorded as a decrease in income tax expense and resulted in a
$0.38
increase in our first-quarter basic earnings per share in the condensed consolidated statement of income.
Recently issued accounting pronouncements
In May 2017, the FASB issued a new accounting standard update which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The amendments are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. We are currently evaluating the impact of adopting this standard on the consolidated financial statements and disclosures, but do not expect it to have a significant impact on our condensed consolidated financial statements.
In January 2017, the FASB issued a new accounting standard update on simplifying the accounting for goodwill impairment. The new guidance eliminates the requirement to calculate the implied fair value of goodwill (i.e., Step 2 of the goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. This guidance will be effective for interim or annual goodwill impairment tests in fiscal years beginning after December 15, 2019 and will be applied prospectively. Early adoption is permitted for any impairment tests performed after January 1, 2017. The Company does not believe that this guidance will have a material impact on our condensed consolidated financial statements.
In November 2016, the FASB issued an update which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statement of cash flows. 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. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. We are still evaluating the effect of this guidance and have not yet completed the analysis of how adopting this update will affect our condensed consolidated financial statements and disclosures.
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 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 Company is still evaluating the effect of the update on our financial statements and internal controls over financial reporting but does not believe that the impact of adopting this pronouncement will be material to the condensed consolidated financial statements.
In May 2014, the FASB issued an amendment to its accounting guidance related to revenue recognition. This guidance supersedes existing revenue recognition standards and is based on the principle that an entity should recognize revenue 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. In addition, new and enhanced disclosures will be required. For a public entity, the standard becomes effective for annual and interim reporting periods beginning after December 15, 2017. For all other entities, the amendments in this update are effective for reporting periods beginning after December 15, 2018. The new standard is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of its application recognized at the date of initial application. We have not yet selected a transition method. We are managing the implementation of this new standard in close consultation with our Audit Committee. We have established a cross functional project steering committee and implementation team to identify potential differences that would result from applying the requirements of the new standard to our revenue contracts and related expense line items. We have identified the various revenue streams, including product revenues and service revenues that could be impacted by the new standard and have started to review individual customer contracts related to these revenue streams to determine if any material differences exist between the current and new revenue standards. We have not completed our assessment of the new revenue recognition standard and have not yet determined the impact of adoption on our condensed consolidated financial statements. We anticipate that we will complete our assessment of the new standard and the potential financial impact by the end of the first quarter of fiscal year 2018. We will adopt this guidance on December 31, 2018, the date our emerging growth company status expires.
2. Variable Interest Entities
As of
September 30, 2017
, 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. As of
September 30, 2017
, we hold
100%
of the voting power in HPIH, but
76.6%
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 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 as a result of our involvement in this VIE is the net income or loss allocated to us based on our interest.
3. Goodwill and Intangible Assets
Goodwill
Our goodwill balance as of
September 30, 2017
and
December 31, 2016
of
$41.1 million
arose from previous acquisitions as described in our Annual Report on Form 10-K for the year ended
December 31, 2016
. There have been no changes in the carrying amounts of goodwill.
Other intangible assets
Our other intangible assets arose primarily from previous acquisitions described in our Annual Report on Form 10-K for the year ended
December 31, 2016
and consist of a brand, the carrier network, distributor relationships, noncompete agreements, customer relationships, and capitalized software. Finite-lived intangible assets are amortized over their useful lives from
two
to
fifteen years
.
Major classes of intangible assets as of
September 30, 2017
consisted of the following ($ in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average Amortization (years)
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Intangible Assets, net
|
Brand
|
14.1
|
|
$
|
1,377
|
|
|
$
|
(375
|
)
|
|
$
|
1,002
|
|
Carrier network
|
5.0
|
|
40
|
|
|
(40
|
)
|
|
—
|
|
Distributor relationships
|
6.8
|
|
4,059
|
|
|
(3,279
|
)
|
|
780
|
|
Noncompete agreements
|
4.7
|
|
987
|
|
|
(987
|
)
|
|
—
|
|
Customer relationships
|
5.8
|
|
1,484
|
|
|
(1,147
|
)
|
|
337
|
|
Capitalized software
|
6.7
|
|
8,571
|
|
|
(4,285
|
)
|
|
4,286
|
|
Total intangible assets
|
|
|
$
|
16,518
|
|
|
$
|
(10,113
|
)
|
|
$
|
6,405
|
|
Major classes of intangible assets as of
December 31, 2016
consisted of the following ($ in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average Amortization (years)
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Intangible Assets, net
|
Brand
|
14.1
|
|
$
|
1,377
|
|
|
$
|
(311
|
)
|
|
$
|
1,066
|
|
Carrier network
|
5.0
|
|
40
|
|
|
(40
|
)
|
|
—
|
|
Distributor relationships
|
6.8
|
|
4,059
|
|
|
(2,831
|
)
|
|
1,228
|
|
Noncompete agreements
|
4.7
|
|
987
|
|
|
(881
|
)
|
|
106
|
|
Customer relationships
|
5.8
|
|
1,484
|
|
|
(1,125
|
)
|
|
359
|
|
Capitalized software
|
6.7
|
|
8,571
|
|
|
(3,423
|
)
|
|
5,148
|
|
Total intangible assets
|
|
|
$
|
16,518
|
|
|
$
|
(8,611
|
)
|
|
$
|
7,907
|
|
Amortization expense for the
three months ended September 30, 2017
and
2016
was
$479,000
and
$527,000
, respectively, and for the
nine months ended September 30, 2017
and 2016 was
$1.5 million
and
$1.6 million
, respectively.
Estimated annual pretax amortization of intangible assets for the remainder of 2017 and for each of the next five years and thereafter are as follows ($ in thousands):
|
|
|
|
|
Remainder of 2017
|
$
|
463
|
|
2018
|
1,725
|
|
2019
|
1,338
|
|
2020
|
1,338
|
|
2021
|
685
|
|
2022
|
114
|
|
Thereafter
|
742
|
|
Total
|
$
|
6,405
|
|
4. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following as of ($ in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
Carriers and vendors payable
|
$
|
13,643
|
|
|
$
|
11,385
|
|
Commissions payable
|
5,896
|
|
|
5,710
|
|
Accrued wages
|
5,888
|
|
|
4,206
|
|
Accrued refunds
|
1,746
|
|
|
3,238
|
|
Accounts payable
|
624
|
|
|
928
|
|
Accrued professional fees
|
1,755
|
|
|
910
|
|
Accrued credit card/ACH fees
|
403
|
|
|
430
|
|
Accrued restructuring
|
—
|
|
|
3
|
|
Other accrued expenses
|
1,561
|
|
|
2,870
|
|
Total accounts payable and accrued expenses
|
$
|
31,516
|
|
|
$
|
29,680
|
|
5. 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. 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, except as otherwise required by applicable law. As of
September 30, 2017
, the Class A common stockholders had
76.6%
of the voting power in HIIQ and the Class B common stockholders had
23.4%
of the voting power in HIIQ. Holders of shares of our Class A common stock have
100%
of the economic interest in HIIQ. Holders of Class B common stock do
no
t have an economic interest in HIIQ.
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 into 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 HIIQ, 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 Class A 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 a 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.
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”). All of the Series B Membership Interests are held by HPI and HPIS, which are two legal entities owned by Michael Kosloske, the founder and a director of the Company. 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 9 from our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended
December 31, 2016
for further information on the Exchange Agreement.
On February 1, 2014, a registration statement on Form S-3 became effective under which we registered
8,566,667
shares of our Class A common stock for resale from time to time by HPI and HPIS, of which all such shares are issuable upon the exchange of an equivalent number of Series B Membership Interests (together with an equal number of shares of our Class B common stock).
On March 13, 2017, HPI and HPIS (the “Selling Stockholders”) completed a secondary underwritten public offering of
3,000,000
shares of our Class A common stock under the above-described Form S-3 registration statement. In connection with the offering, on March 8, 2017, we entered into an underwriting agreement with Canaccord Genuity Inc., Cantor Fitzgerald & Co., Northland Securities, Inc., and Lake Street Capital Markets, LLC, collectively as the underwriters, and the Selling Stockholders. Immediately prior to the completion of the offering, we issued
3,000,000
shares of Class A common stock to the Selling Stockholders. In exchange for the issuance of the shares, we immediately acquired
3,000,000
Series B Membership Interests, together with an equal number of shares of our Class B common stock from the Selling Stockholders. These Series B Membership Interests were immediately recapitalized into Series A Membership Interests in HPIH. The Selling Stockholders agreed to, immediately after the exchange, sell to the underwriter for resale all
3,000,000
shares of Class A common stock at a public offering price of
$14.00
per share (
$13.16
per share, net of underwriting discounts), for net proceeds of
$39.5 million
. No shares were sold by the Company in this offering. The acquisition of the Series B Membership Interests resulted in a decrease in noncontrolling interests with an offsetting increase in stockholders’ equity as of March 31, 2017 to reflect the decrease in the noncontrolling interest’s investment in HPIH. See Note 9 for further discussion on the tax receivable agreement we entered into with holders of Series B Membership Interests.
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 HIIQ 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, 2017
and
December 31, 2016
, we held
141,434
and
119,544
shares of treasury stock, respectively, recorded at a cost of
$1.6 million
and
$1.1 million
, respectively.
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, 2017
, there were
10,263
and
21,890
shares, respectively, transferred to Treasury for statutory tax withholding obligations as a result of vested restricted stock awards.
No
shares were transferred to Treasury as a result of forfeitures of restricted stock awards during the
three and nine months ended
September 30, 2017
. There was no other Treasury activity during the
three and nine months ended
September 30, 2017
.
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
shares and
43,600
, respectively, were transferred to Treasury as a result of forfeitures of restricted stock awards.
Registration Statement on Form S-3
On May 5, 2017, the Company filed a registration statement on Form S-3, effective May 19, 2017, to offer and sell, from time to time, up to
$150 million
of any combination of debt securities, Class A Common Stock, preferred stock, warrants, subscription rights, units, or purchase contracts as described in the related prospectus. Securities may be sold in one or more classes or series and in amounts, at prices and on terms that we will determine at the times of the offerings and we may offer the securities independently or together in any combination for sale directly to purchasers or through underwriters, dealers or agents to be designated at a future date. We intend to use the net proceeds from the sale of the securities for general corporate purposes, including potentially expanding existing businesses, acquiring businesses and investing in other business opportunities. At
September 30, 2017
, the Company had not sold any securities under this Registration Statement.
6. 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 stock appreciation rights (“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 and
2,000,000
additional shares were further reserved for issuance in prior years shareholder approvals. The Company’s shareholders approved an increase of
2,000,000
shares of Class A common stock reserved for issuance in May 2017 under the LTIP and as of
September 30, 2017
, there were
5,250,000
total shares reserved 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. 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 a term equivalent to the expected term. Compensation expense is recognized only for those awards expected to vest, with forfeitures estimated based on our historical experience and future expectations.
No
stock-based compensation was capitalized during the
three and nine months ended September 30, 2017
and
2016
, respectively.
The Black-Scholes option-pricing model was used with the following weighted average assumptions:
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
Risk-free rate
|
1.7
|
%
|
|
1.2
|
%
|
Expected life
|
4.8 years
|
|
|
4.6 years
|
|
Expected volatility
|
64.0
|
%
|
|
56.5
|
%
|
Expected dividend
|
none
|
|
|
none
|
|
The following table summarizes restricted shares, SARs, and stock options granted during the
three and nine months ended September 30, 2017
and
2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Restricted shares
|
—
|
|
|
28
|
|
|
855
|
|
|
54
|
|
SARs
|
100
|
|
|
104
|
|
|
185
|
|
|
703
|
|
Stock options
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
There were
no
Restricted shares granted for the
three months ended September 30, 2017
. The weighted average fair value of Restricted shares granted was
$21.94
for the
nine months ended September 30, 2017
with an aggregate intrinsic value of
$18.8 million
. The weighted average fair value of SARs granted during the
three and nine months ended September 30, 2017
, was
$16.51
and
$14.30
, respectively. For each of the
three and nine months ended September 30, 2016
, the weighted average fair value of Restricted shares granted was
$5.69
and
$6.22
with an aggregate intrinsic value of
$157,600
and
$337,600
, respectively. The weighted average fair value of SARs granted during the
three and nine months ended September 30, 2016
was
$2.47
and
$3.13
, respectively. For all new grants in
2017
and
2016
, the Company utilized an estimated pre-vest forfeiture rate of
7.0%
.
The following table summarizes stock-based compensation expense for the
three and nine months ended September 30, 2017
and
2016
($ in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Restricted shares
|
$
|
2,246
|
|
|
$
|
(41
|
)
|
|
$
|
3,306
|
|
|
$
|
254
|
|
SARs
|
434
|
|
|
415
|
|
|
1,116
|
|
|
1,019
|
|
Stock options
|
3
|
|
|
19
|
|
|
15
|
|
|
89
|
|
|
$
|
2,683
|
|
|
$
|
393
|
|
|
$
|
4,437
|
|
|
$
|
1,362
|
|
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, 2017
($ in thousands):
|
|
|
|
|
|
|
|
Unrecognized Expense
|
|
Weighted Average Remaining Years
|
Restricted shares
|
$
|
13,310
|
|
|
2.1
|
SARs
|
2,734
|
|
|
2.2
|
Stock options
|
1
|
|
|
0.2
|
|
$
|
16,045
|
|
|
|
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.
During the
three and nine months ended September 30, 2017
, there were
110,500
and
1.4 million
SARs exercised, respectively, resulting in an increase of
89,800
and
1.0 million
issued shares of Class A common stock, respectively. During the
three months ended September 30, 2017
, there were
no
SARs forfeited. During the
nine months ended
September 30, 2017
, there were
17,500
SARs forfeited.
No
SARs were exercised during the
three and nine months ended September 30, 2016
. During the
three and nine months ended September 30, 2016
, there were
2,250
and
24,250
SARs forfeited, respectively.
During the
three and nine months ended September 30, 2017
, there were
10,700
and
29,500
options exercised, respectively, and
1,200
and
16,480
options exercised during the
three and nine months ended September 30, 2016
, respectively. During the
three and nine months ended September 30, 2017
and
2016
, there were
no
options forfeited.
For the
three months ended September 30, 2017
, there were cash outflows of
$263,000
with respect to shares redeemed to cover the tax obligations for the settlement of vested Restricted stock. For the
nine months ended September 30, 2017
, there was
$448,000
of cash outflows with respect to shares redeemed to cover the recipient’s tax obligations. For the
three and nine months ended September 30, 2016
, respectively, there was cash outflow of
$36,000
and
$75,000
with respect to shares redeemed to cover the recipient’s tax obligations.
We recognized income tax benefits from stock-based activity of
$380,000
and
$4.0 million
for the
three and nine months ended September 30, 2017
, respectively. For the
three and nine months ended September 30, 2016
, we recognized income tax benefits of
$10,000
and
$52,000
, respectively, from stock-based activity. During the three months ended March 31, 2017, the Company elected to early adopt ASU 2016-09,
Improvements to Employee Share-Based Payment Accounting
, and as a result of this adoption, excess tax benefits of
$3.3 million
related to vested and exercised share-based compensation awards were recorded as a decrease in income tax expense which resulted in a
$0.38
increase in our basic earnings per share in the condensed consolidated statement of income. The Company has elected to continue its policy of estimating forfeitures in accordance with the update.
7. Net Income per Share
The computations of basic and diluted net income per share attributable to HIIQ for the
three and nine months ended September 30, 2017
and
2016
were as follows ($ in thousands, except share and per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Basic net income attributable to Health Insurance Innovations, Inc.
|
$
|
3,885
|
|
|
$
|
1,939
|
|
|
$
|
14,102
|
|
|
$
|
4,701
|
|
Weighted average shares—basic
|
11,700,941
|
|
|
7,614,252
|
|
|
10,724,750
|
|
|
7,590,347
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
Restricted shares
|
466,581
|
|
|
67,798
|
|
|
258,218
|
|
|
87,155
|
|
SARs
|
561,788
|
|
|
—
|
|
|
685,583
|
|
|
5,226
|
|
Stock options
|
13,642
|
|
|
41,146
|
|
|
24,204
|
|
|
41,440
|
|
Weighted average shares—diluted
|
12,742,952
|
|
|
7,723,196
|
|
|
11,692,755
|
|
|
7,724,168
|
|
Basic net income per share attributable to Health Insurance Innovations, Inc.
|
$
|
0.33
|
|
|
$
|
0.25
|
|
|
$
|
1.31
|
|
|
$
|
0.62
|
|
Diluted net income per share attributable to Health Insurance Innovations, Inc.
|
$
|
0.30
|
|
|
$
|
0.25
|
|
|
$
|
1.21
|
|
|
$
|
0.61
|
|
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 per share because such inclusion would be antidilutive (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Restricted shares
|
—
|
|
|
31
|
|
|
405
|
|
|
42
|
|
SARs
|
16
|
|
|
131
|
|
|
—
|
|
|
88
|
|
Stock options
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Additionally, potential common stock totaling
3,841,667
shares at
September 30, 2017
and
6,841,667
shares at
September 30, 2016
issuable under an exchange agreement were not included in diluted shares because such inclusion would be antidilutive. See Note 5 for further details on the exchange agreement.
8. 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 condensed consolidated financial statements.
The effective tax rate for the
three and nine months ended September 30, 2017
was
32.5%
and
16.4%
, respectively. The effective tax rate for the
three and nine months ended
September 30, 2016
was
23.4%
and
17.6%
, respectively. For the
three and nine months ended September 30, 2017
the provision for income taxes was
$2.9 million
and
$4.2 million
, 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. 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.
Due to the ownership structure of HP, which is a taxable entity, it cannot join in a consolidated tax filing with HIIQ. Consequently, its federal and state tax jurisdictions are separate from those of HIIQ, which prevents deferred tax assets and liabilities of HIIQ and HP from offsetting one another. The effective tax rate for HIIQ for the
nine months ended
September 30, 2017
was mainly impacted by the tax benefit realized by the early adoption of ASU 2016-09. HP’s
2017
book loss generates a deferred tax benefit which is materially offset by a valuation allowance. As a result, due to the offsetting effect of HP’s pretax book loss and HIIQ’s pretax book income when the two are combined, the deferred tax benefit from HP along with the benefit realized by HIIQ’s early adoption of the accounting update results in a total combined effective tax rate of
16.4%
. On a standalone basis, the effective tax rate for the
three and nine months ended September 30, 2017
for HIIQ was
29.1%
and
15.0%
, respectively, while the effective tax rate for each of the
three and nine months ended September 30, 2017
for HP was
3.7%
.
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, 2017
and
2016
, respectively, we did
no
t 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 no uncertain tax positions outstanding as of
September 30, 2017
and
2016
, respectively. The Company’s 2013 through 2016 tax years remain subject to examination by tax authorities.
9. Commitments and Contingencies
BimSym Agreements
On August 1, 2012, the Company 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 were required to make monthly payments of
$26,000
for
five years
. After the
five
-year term, this agreement automatically renews for one-year terms unless we give 60 days’ notice. As of August 1, 2017, the Company had fulfilled its commitment under the agreement and had not provided notice of cancellation to BimSym thereby automatically renewing the agreement for an additional one-year term.
Additionally, on August 1, 2012 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 A.R.I.E.S. System under which we were required to make monthly payments of
$16,000
for
five years
. The present value of these payments were capitalized and recorded as an intangible asset with a corresponding liability on the accompanying condensed consolidated balance sheets. As of August 1, 2017, both parties to the agreement have fulfilled their commitment.
Tax Receivable Agreement
On February 13, 2013, we entered into a Tax Receivable Agreement (“TRA”) with HPI and HPIH as the holders of the HPIH Series B Membership Interests. 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 HIIQ’s obligation and not an obligation of HPIH. HIIQ 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 expire, unless HIIQ exercises its right to terminate the TRA for an amount based on the agreed payments remaining to be made under the agreement or HIIQ breaches any of its material obligations under the TRA in which case all obligations will generally be accelerated and due as if HIIQ 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 investment in HPIH subject to the provision of the TRA.
We plan to make an election under Section 754 of the Internal Revenue Code. The election would increase our tax basis in the
tangible and intangible assets of HPIH. These increases in tax basis are expected to increase our deductions and therefore may reduce the amount of tax that we would otherwise be required to pay in the future. As of
September 30, 2017
, Series B Membership Interests, together with an equal number of shares of Class B common stock have been exchanged for a total of
4,825,000
shares of Class A common stock subsequent to the IPO. See Note 5 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
$28.6 million
pursuant to the TRA as of
September 30, 2017
. We have determined that this amount is probable of being paid based on our estimates of future taxable income. This liability represents the share of tax benefits payable to the entities beneficially owned by Mr. Kosloske, if we generate sufficient taxable income in the future. As of
December 31, 2016
, we reversed the valuation allowance on our deferred tax assets related to the TRA. The exchange transactions created a tax benefit to be shared by the Company and the entities beneficially owned by Mr. Kosloske. As of
September 30, 2017
, we have made
$672,000
of the payments due under the TRA.
Distributor Advanced Commissions, net
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 on the condensed consolidated balance sheets. Certain of these agreements may include a loan agreement and a UCC-1 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. As of
September 30, 2017
, the Company has recorded an allowance for bad debt of
$263,000
.
Credit Agreement
On July 17, 2017, the Company, through HPIH, entered into a Credit Agreement (the “Credit Agreement”) among HPIH, and certain of its affiliates as guarantors, and SunTrust Bank, as lender (the “Lender”). The Credit Agreement provides for a
$30.0 million
revolving credit facility (the “Credit Facility”) pursuant to which the Lender has agreed to make revolving loans and issue letters of credit. The Credit Facility will be used for general corporate purposes, including funding of ongoing working capital needs, capital expenditures, and permitted acquisitions. The Credit Facility also provides HPIH with the right to request additional incremental term loans thereunder up to an aggregate additional amount of
$20 million
, subject to the satisfaction of certain additional conditions provided therein.
The Credit Facility matures on July 17, 2020 (the “Termination Date”) and borrowings under the Credit Agreement can either be, at HPIH’s election: (i) at the Base Rate (which is the highest of the prime rate, the federal funds rate plus
0.50%
, the one-month LIBOR index rate plus
1.00%
, and
zero
) plus a spread ranging from
0.75%
to
1.25%
or (ii) at Adjusted LIBOR (as defined in the Credit Agreement) plus a spread ranging from
1.75%
to
2.25%
. The applicable spread is dependent upon HPIH’s Consolidated Total Leverage Ratio (as defined in the Credit Agreement). Interest accrued on each Base Rate Loan (as defined in the Credit Agreement) is payable in arrears on the last day of each calendar quarter and on the Termination Date. Interest accrued on each Eurodollar Loan (as defined in the Credit Agreement) is payable on the last day of the applicable interest period, or every three months, whichever comes sooner, and on the Termination Date. As of
September 30, 2017
, there were
no
borrowings against the Credit Facility and there was
$30.0 million
available to be drawn upon.
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
Indiana Multistate Market Conduct Examination
The Company received notification in April 2016 from the Indiana Department of Insurance that a multistate examination had 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. In May 2016, the Company received notice that the Market Actions Working Group of the National Association of Insurance Commissioners determined that the examination would become a multistate examination. As the Company was a program manager of HCC products at that time, 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 is serving as the managing participant of the multistate examination, and the examination includes, among other things, a review of whether HCC (and the Company) has engaged in any unfair or deceptive acts or non-compliant insurance business practices. At present, forty-two states have joined the multistate examination. On June 1, 2016, the Company responded to an initial document production request in this matter. The Company received notice on March 16, 2017 that Indiana may expand the scope and time period of the examination to include a review of the Company’s marketing, sales, and administration of insurance products for all parties with whom HIIQ conducted business. This notice was provided through an additional “warrant” which is similar to an investigatory subpoena. Additional discussions with the lead investigators took place on March 29, 2017, in which the Company sought modifications to the scope of any potential expansion, and offered to provide additional information on a voluntary basis, but in the meantime, the Company has nevertheless focused on providing the information requested by the expanded warrant. In addition to the multistate examination led by Indiana, we are aware that several other states, including Florida and South Dakota are reviewing the sales practices and potential unlicensed sale of insurance by independently owned and operated licensed-agent call centers utilized by the Company.
The Company is aware of and managing additional claims and inquiries in other states that, except for the inquiries described below, the Company does not believe are material at this time. Except as otherwise described below, 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, and has provided a detailed action plan to regulators that summarizes the Company’s enhanced compliance and control mechanisms.
Montana Regulatory Action
In May 2016, the Company received notification from the Office of the Montana State Auditor, Commissioner of Securities and Insurance (“CSI”) that an administrative action had 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, and the CSI temporarily suspended the Company’s license to conduct business in Montana pending resolution of the matter and agreed to a hearing in the matter. Following a series of communications with the CSI and the provision of information to the CSI, on September 15, 2017, the CSI formally declared to the hearing examiner that it was joining the multistate and requested dismissal of all HIIQ entities from the Notice of Proposed Agency Action. This request was granted on October 31, 2017, and the Company is now dismissed from the action. As a result, the Company’s exposure related to this matter, if any, will now be tied to Montana’s involvement in the multistate examination.
Massachusetts Regulatory Action
The Company received notification of a civil investigative demand from the Massachusetts Attorney General’s Office (“MAG”) on June 16, 2016. As part of the MAG’s regulatory oversight of the Massachusetts health care system and its corresponding authority to request documents from market participants, the MAG has requested certain information and documents from the Company. The information requested will be used to review the Company’s sales and marketing practices, and ensure the Company is in compliance with Massachusetts laws and regulations. Additionally, the Company’s materials and sales and marketing practices will be evaluated in order to ensure that they are neither deceptive nor do they constitute unfair trade practices.
The Company continues to provide all requested documents and materials requested by the MAG, and is in the process of assembling some additionally-requested information. The Company continues to cooperate with the MAG in the interest of bringing the matter to an agreeable conclusion. While the MAG has indicated it is amenable to exploring all available options, and it is still too early to assess whether the MAG’s investigation will result in a material impact on the Company, the Company believes that based on the nature of the allegations raised by the MAG during the fourth quarter of 2016, a loss arising from the future assessment of a civil penalty against the Company is probable. Notwithstanding, due to the relatively procedural stage of the investigative process, the recent settlement of another party (a carrier) for the same set of allegations, and the fact that the Company has neither requested nor received evidentiary material from the MAG, the Company is currently unable to estimate the amount of any potential civil penalty or determine a range of potential loss under the MAG’s investigation of the Company. It is possible there may be no financial loss, a nominal or minimal loss, or some other mutually satisfactory resolution reached with the MAG in connection with the MAG’s investigation of the Company.
Texas Regulatory Action
In September 2016, the Texas Department of Insurance (“TDI”) notified the Company that it has instituted an enforcement action to investigate alleged violations of advertising rules and third-party administrator license requirements in connection with the sale of the Company’s products. In connection with the investigation, the TDI requested certain information, records, and explanations and the Company delivered a response and the requested information and records in November 2016. Following such date, the TDI took no action, and communicated only that it was continuing to review the matter. In May 2017, the TDI communicated a series of additional requests for information, and the results were provided two weeks later. Since that time, there has been no additional communication from the TDI. The Company’s position is that there have been no violations of the advertising or third-party administrator statutes in Texas, although there is no assurance that the TDI will agree with this position. This action has developed slowly, and accordingly the Company has not determined any potential loss to be probable. Additionally, due to the early stage of the matter any potential loss is not reasonably estimable. Accordingly, no loss or range of loss has been recorded or disclosed.
We are proactively communicating and cooperating with all regulatory agencies involved in the above-described examinations and actions and we have recently developed and enhanced our compliance and control mechanisms. However, it is too early to determine whether any of these regulatory matters will have a material impact on our business. Any adverse finding could result in significant penalties or other liabilities and/or a requirement to modify our marketing or business practices and the practices of our third-party distributors, which could harm our business, results of operations or financial condition. Moreover, an adverse regulatory action in one jurisdiction could result in penalties and adversely affect our license status or reputation in other jurisdictions due to the requirement that adverse regulatory actions in one jurisdiction be reported to other jurisdictions.
Miscellaneous
Purported Securities Class Action Lawsuits
In September 2017, three putative securities class action lawsuits were filed against the Company and certain of its current and former executive officers. The cases are styled
Cioe Investments Inc. v. Health Insurance Innovations, Inc., Gavin Southwell, and Michael Hershberger
, Case No. 1:17-cv-05316-NG-ST, filed in the U.S. District Court for the Eastern District of New York on September 11, 2017;
Michael Vigorito v. Health Insurance Innovations, Inc., Gavin Southwell, and Michael Hershberger
, Case No. 1:17-cv-06962, filed in the U.S. District Court for the Southern District of New York on September 13, 2017; and
Shilpi Kavra v. Health Insurance Innovations, Inc., Patrick McNamee, Gavin Southwell, and Michael Hershberger
, Case No. 8:17-cv-02186-EAK-MAP, filed in the U.S. District Court for the Middle District of Florida on September 21, 2017. All three of the foregoing actions (the “Securities Actions”) were filed after a decline in the trading price of the Company’s common stock following the release of a report authored by a short-seller of the Company’s common stock raising questions about, among other things, the Company’s public disclosures relating to the Company’s regulatory examinations and regulatory compliance. All three of the Securities Actions, which are based substantially on the allegations raised in the short-seller report, contain substantially the same allegations and allege that the Company made materially false or misleading statements or omissions relating to regulatory compliance matters, particularly regarding to the Company’s application for a third-party administrator license in the State of Florida. The Securities Actions allege violations of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), SEC Rule 10b-5, and Section 20(a) of the Exchange Act. According to the filed complaints, the p
laintiffs in the Securities Actions are seeking an undetermined amount of damages, interest, attorneys’ fees and costs on behalf of putative classes of individuals and entities that acquired shares of the Company’s common stock on periods ending September 11, 2017. The Company was served on October 24, 2017 in the
Kavra
case but has not yet been served with the complaints in the other actions. The Company intends to vigorously defend against the claims. It is possible that similar lawsuits may yet be filed in the same or other courts that name the same or additional defendants.
TPA Licensure
On September 29, 2017, the Company and the Florida Office of Insurance Regulation (“OIR”) entered into a mutual consent order relating to the Company’s application for licensure as a third-party insurance administrator (“TPA”) in the State of Florida. Prior to the consent order, in June 2017, the OIR denied the Company’s previously filed TPA application based on the OIR’s determination that the Company had not provided all information required to process the application, and in June 2017, the Company appealed the denial with the Florida Division of Administrative Hearings. Pursuant to the consent order, on October 2, 2017, the Florida Division of Administrative Hearings granted a motion to dismiss the Company’s petition contesting the OIR’s prior license denial, and on October 4, 2017, the OIR withdrew its prior denial of the Company’s TPA license application. The mutual consent order between the Company and the OIR specifies details regarding the information to be included in the Company’s new TPA application and certain procedural steps, such as a pre-submission meeting with the OIR. On October 17, 2017, the Company and the OIR held the pre-submission meeting, and the Company submitted the new TPA application in accordance with the consent order immediately following the meeting. The application is currently under active review by the staff of the OIR.
Telephone Consumer Protection Act
The Company has received a number of private-party claims relating to alleged violations of the federal Telephone Consumer Protection Act (TCPA) by its independently owned and operated licensed-agent distributors, alleging that their marketing activities were potentially unlawful. The Company has been named as a defendant in multiple lawsuits relating to alleged TCPA matters, including claims styled, but not yet certified, as class actions. There are three primary cases filed in the courts by Plaintiffs Craig Cunningham, Kenneth Moser, and Amanda Hicks, each styled as a class action but not yet certified, and each Plaintiff alleging or seeking damages ranging from
$160,000
to over
$5,000,000
. The Company is defending these claims and has filed motions to dismiss or the equivalent in each matter. The Company is presently reviewing these matters and reviewing distributor compliance, and enhancing existing compliance. While these types of claims have previously settled or resolved without any material effect on the Company, there is a possibility in the future that one or more could have a material effect. The Company requires that its independently owned and operated licensed-agent distributors reimburse or indemnify it for any such settlements.
Other
The Company has previously received inquiries but no claims, litigation, or findings of violation relating to alleged data loss and/or privacy breaches relating to affiliated companies. Each allegation is investigated upon receipt and handled promptly to resolution.
The Company has received claims relating to customer service and claims handling issues arising from a prior carrier’s, HCC Life Insurance Company (“HCC”), relationship to the Company. Recently, in one of the matters styled as
Azad, et al. v. Tokio Marine HCC, et al.
, Case No. Case 3:17-cv-00618, U.S. District Court for the Northern District of California, (“Azad case”) the Company sought and received dismissal from the matter initially without prejudice, and subsequently on September 22, 2017, the Company was dismissed with prejudice from the case. The Company independently filed its own lawsuit against that same carrier, HCC, seeking that the Court ascertain and declare the rights and obligations between the parties. That declaratory action was filed in Hillsborough County, Florida and is styled as
Health Insurance Innovations, Inc., et al. v. HCC Medical Insurance Services, LLC, et al.
, Case No. 17-CA-6679. This declaratory action was filed in response to indemnity demands that the Company received from HCC. No lawsuit has been filed against the Company by HCC, and on August 18, 2017, HCC sent a letter to the Company limiting the scope of its indemnification demand to the Montana administrative matter discussed above (that the Company has been dismissed from), the multistate review discussed above, and the Azad case. Following the Company’s dismissal from the Azad case, on September 29, 2017 HCC sent an additional letter to the Company further limiting the scope of its indemnification demand by removing the Azad case.
The Company has also received claims from insureds relating to lack of carrier coverage, claims handling, and alleged deceptive sales practices relating to this carrier. In each of these individual insureds’ claims, the Company attempts to dismiss, challenge or resolve the claims as quickly as possible.
10. Fair Value Measurements
We measure and report financial assets and liabilities at fair value. 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.
Noncompete obligation.
Our noncompete obligation, an exclusivity agreement with the developer of the A.R.I.E.S System as described in Note 9, 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, and accounts payable and accrued expenses as of
September 30, 2017
and
December 31, 2016
, respectively, approximate fair value because of the short-term duration of these instruments.
As of
September 30, 2017
, there were no remaining liabilities measured at fair value. As of
December 31, 2016
, our liabilities measured at fair value were as follows ($ in thousands):
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Carrying Value
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Fair Value Measurement as of December 31, 2016
|
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as of
December 31, 2016
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Level 1
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Level 2
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Level 3
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Liabilities:
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Noncompete obligation
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$
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110
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$
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—
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$
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110
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$
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—
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$
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110
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$
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—
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$
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110
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$
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—
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11. 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 the managing member. During the
nine months ended
September 30, 2017
, HPIH paid cash distributions of
$5.3 million
for these entities related to estimated federal and state income taxes, pursuant to the operating agreement entered into by HPIH and HPI. Of this,
$2.8 million
related to amounts accrued for at
December 31, 2016
. For the
nine months ended
September 30, 2016
,
$86,000
in cash distributions were made for estimated federal and state income taxes. 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. As of
September 30, 2017
, we have
no
accrued payments due to member, other than the TRA liability disclosed below, recorded in the condensed consolidated balance sheet. At
December 31, 2016
we had accrued
$2.8 million
for estimated tax liabilities due to our members.
Tax Receivable Agreement
As discussed in Note 9, 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, 2017
, we are obligated to pay
$28.6 million
pursuant to the TRA, of which
$521,000
is included in current liabilities and
$28.1 million
is included in long-term liabilities on the accompanying condensed consolidated balance sheets. As of
September 30, 2017
, we have made cumulative payments under the TRA of
$672,000
.
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.
12. Subsequent Events
On October 13, 2017, the Company’s Board of Directors authorized a share repurchase program for up to
$50 million
of the Company’s outstanding Class A Common Stock. The share repurchase authorization permits the Company to periodically repurchase shares for cash for a period of
24 months
in open market purchases, block transactions and privately negotiated transactions in accordance with applicable federal securities laws. The actual timing, number and value of shares repurchased under the program will be determined by the Company’s management at its discretion and will depend on a number of factors, including the market price of the Company’s common stock, general market and economic conditions, regulatory requirements, capital availability and compliance with the terms of the Company’s credit facility. Repurchases under the program will be funded from one or a combination of existing cash balances, future free cash flow, and indebtedness. There is no guarantee as to the number of shares that will be repurchased, and the repurchase program may be extended, suspended or discontinued at any time without notice at the Company’s discretion.