Notes to 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 in this report to the Company, we, us and our refer (1) prior to the February 13, 2013 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 our 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. HPIH and ICE are consolidated subsidiaries of HII.
Business Description and Organizational Structure of the Company
Our Business
We are a developer and administrator of affordable individual health insurance and discount benefit plans that are sold throughout the United States. Our main product, short-term medical (STM) insurance, is an alternative to traditional individual major medical plans and generally offers comparable benefits for qualifying individuals. We also offer guaranteed-issue hospital indemnity plans for individuals under the age of 65 and a variety of ancillary products that are frequently purchased together with the STM and hospital indemnity plans as supplements. We design and structure insurance products on behalf of our contracted insurance carrier companies; market them to individuals through a network of distributors; and manage our relationships with our customers whom are referred to as members, through our customer service agents. Our sales are primarily executed online and offer real-time fulfillment through our proprietary web-based technology platform, through which we receive credit card and automated clearing house (ACH) payments directly from the members at the time of sale. In certain cases, premiums are collected from the distributor. The plans are underwritten by contracted insurance carrier companies, and we assume no underwriting or insurance risk.
Our History
Our business began operations in 2008, and historically, we operated through HPI. In August 2008, Naylor Group Partners, LLC (Naylor) made a capital contribution to HPI in exchange for a 50% ownership interest in HPI. In September 2011, HPI purchased all of the units owned by Naylor for $5.3 million plus financing costs of $135,000. HPI financed a portion of the purchase price by entering into a loan agreement with a bank for $4.3 million. The remaining purchase price was funded with HPI cash and a contribution from Michael Kosloske (Mr. Kosloske), our Chairman, President and Chief Executive Officer. Following the purchase, Mr. Kosloske became the sole member of HPI.
Our Reorganization and the IPO
Health Insurance Innovations, Inc. was incorporated in the State of Delaware on October 26, 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 6 for more information about the IPO.
In anticipation of the IPO, on November 7, 2012, HPI assigned the operating assets of our business through a series of transactions to HPIH, and HPIH assumed the operating liabilities of HPI.
Our Organizational Structure after the IPO
Health Insurance Innovations, Inc. 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, Health Insurance Innovations, Inc. 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 June 30, 2013, Mr. Kosloske beneficially owns 61.7% 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, and has effective control over the outcome of votes on all matters requiring approval by our stockholders.
8
Health Insurance Innovations, Inc. is a holding company owning as its principal asset Series A Membership Interests in HPIH. HPIH has two series of outstanding equity: Series A Membership Interests, which may only be issued to Health Insurance Innovations, Inc., 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 June 30, 2013, (i) the Series A Membership Interests held by Health Insurance Innovations, Inc. represent 38.3% of the outstanding membership interests, 38.3% 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 61.7% of the outstanding membership interests, 61.7% of the economic interests and no voting interest in HPIH.
For greater detail regarding our organizational structure, our capitalization, the exchange agreement referenced below and related matters, see Item 1. BusinessOur History and the Reorganization of Our Corporate Structure set forth in our annual report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2013.
Exchange Agreement
On February 13, 2013, we entered into an exchange agreement (the Exchange Agreement) with the holders of 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. In connection with each exchange, HPIH will cancel the delivered Series B Membership Interests and Class B common stock and issue to us Series A Membership Interests on a one-for-one basis. Thus, as holders exchange their Series B Membership Interests for Class A common stock, our interest in HPIH will increase
.
Holders will not have the right to exchange Series B Membership Interests if we determine that such exchange would be prohibited by law or regulation or would violate other agreements to which we may be subject. We may impose additional restrictions on the exchange that we determine necessary or advisable so that HPIH is not treated as a publicly traded partnership for U.S. federal income tax purposes. If the Internal Revenue Service were to contend successfully that HPIH should be treated as a publicly traded partnership for U.S. federal income tax purposes, HPIH would be treated as a corporation for U.S. federal income tax purposes and thus would be subject to entity-level tax on its taxable income.
We and the exchanging holder will each generally bear our own expenses in connection with an exchange, except that, subject to a limited exception, we are required to pay any transfer taxes, stamp taxes or duties or other similar taxes in connection with such an exchange.
Tax Receivable Agreement
The purchase of Series B Membership Interests (together with an equal number of shares of our Class B common stock) with the net proceeds from the sale of shares reserved to cover over-allotments from the IPO, as well as subsequent 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 HPIHs tangible and intangible assets. These increases in tax basis are expected to increase our depreciation and amortization income tax deductions and create other tax benefits and therefore may reduce the amount of income tax that we would otherwise be required to pay in the future.
On February 13, 2013, we entered into a tax receivable agreement with the holders of Series B Membership Interests (currently HPI and HPIS, which are beneficially owned by Mr. Kosloske). The agreement 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 tax receivable agreement) as a result of any possible future increases in tax basis described above and of certain other tax benefits related to entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement itself. This is HIIs obligation and not an obligation of HPIH. HII will benefit from the remaining 15% of any realized cash savings. For purposes of the tax receivable agreement, 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 tax receivable agreement itself. The tax receivable agreement 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 tax receivable agreement 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 tax receivable agreement 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
9
the tax receivable agreement 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. For further information on the tax receivable agreement, see Note 13.
Basis of Presentation
The consolidated financial statements reflect the results of operations of HPI through the closing of the IPO on February 13, 2013, and HII subsequent to the IPO.
The consolidated financial statements include our accounts and those of our controlled subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
Our accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934 and do not include all of the information and notes required by U.S. generally accepted accounting principles (GAAP) for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments and accruals) considered necessary for a fair presentation of consolidated financial position, results of operations and cash flows have been included. The consolidated balance sheet data for the year ended December 31, 2012 was derived from our audited financial statements, but does not include all the disclosures required by GAAP. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2012, including the consolidated financial statements and accompanying notes.
Noncontrolling interests are included in the consolidated balance sheets as a component of stockholders equity that is not attributable to the equity of HII. We report separately the amounts of consolidated net income or loss attributable to us and noncontrolling interests.
As an emerging growth company as defined in the Jumpstart Our Business Startups Act of 2012 (the JOBS Act), we intend to take advantage of 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. These exemptions will apply for a period of five years following the completion of our IPO although 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.
Use of Estimates
The preparation of the 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 financial statements. These estimates also affect the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.
Significant Accounting Policies
Revenue recognition
Our revenues consist of commissions earned for health insurance policies and discount benefit plans issued to members, enrollment fees paid by members, and administration fees paid by members as a direct result of our enrollment services. The cash amounts that we receive from payments by members are referred to as premium equivalents. We report revenues net of premiums remitted to insurance carriers and fees paid to vendors of discount benefit plans. Revenues are net of an allowance for policies expected to be cancelled by members. We establish the allowance for estimated policy cancellations through a charge to revenues. The allowance is estimated using historical data to project future experience. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported. We periodically review the adequacy of the allowance and record adjustments as necessary. The net allowance for estimated policy cancellations was $77,000 as of June 30, 2013 and December 31, 2012.
Revenue is earned at the time of sale, which coincides with the policy effective date. Premium equivalents are paid by the members at the time of sale. Upon payment by the member, the member immediately receives all policy-related documents, including their insurance card, in electronic format, thereby completing delivery and our responsibility with respect to the sale transaction. Commission rates for all of our products are agreed to in advance with the relevant insurance carrier and vary by carrier and policy type. Under our carrier compensation arrangements, the commission rate schedule that is in effect on the policy effective date governs the commissions over the life of the policy. In addition, we earn enrollment and administration fees on policies issued. All amounts due to insurance carriers and discount benefit vendors are reported and paid to them according to the procedures provided for in the contractual agreements between us and the individual carrier or vendor. Risk premiums representing the amounts due to and
10
remitted to our carriers, are typically reported and remitted to insurance carriers on the 15
th
day of the month following the end of the month in which they are collected.
In concluding that revenues should be reported on a net basis, we considered Financial Accounting Standards Board (FASB) requirements and whether we have the responsibility to provide the goods or services to the customer or if it relies on a supplier to provide the goods or services to the customer. We are not the ultimate party responsible for providing the insurance coverage or discount benefits to the member and, therefore, we are not the primary obligor in the arrangement. The supplier, or insurance carrier, bears the risk for that insurance coverage. We therefore report our revenues net of amounts paid to its contracted insurance carrier companies and discount benefit vendors.
Third-party commissions and advanced commissions
We utilize a broad network of licensed third-party distributors to sell the plans that we develop. We pay commissions that vary by the type of policy to these distributors based on a percentage of the policy premiums. We pay additional commissions to the distributors for discount benefit plans issued. We record commission expense in the period in which the distributors earn the commissions.
Advanced commissions consist of amounts advanced to certain third-party distributors. We perform ongoing credit evaluations of our distributors, all of which are located in the United States. We recover the advanced commissions from future commissions earned on premiums collected. We have not experienced any credit losses from commission advances and, accordingly, have not recognized a provision for bad debt for the periods presented. A fee for the advanced commission of up to 2% of the insurance premium sold is charged to the distributors and recognized as income as earned. The interest income earned from advanced commissions was $28,000 and $4,000 for the three months ended June 30, 2013 and June 30, 2012, respectively, and $47,000 and $10,000 for the six months ended June 30, 2013 and June 30, 2012, respectively and is included in other (income) expense on the accompanying consolidated statements of operations. The balance of advanced commissions was $2.5 million and $297,000 as of June 30, 2013 and December 31, 2012, respectively.
Cash and cash equivalents and short-term investments
We account for cash on hand and demand deposits with banks and other financial institutions as cash. Short-term, highly liquid investments with original maturities of three months or less are considered cash equivalents. Investments in cash equivalents include, but are not limited to, demand deposit accounts, money market accounts and certificates of deposit with maturities of three months or less.
Periodically, we invest cash on hand in other short-term, highly-liquid investments. Such investments that have maturities greater than three months are classified as short-term investments and include, but are not limited to, certificates of deposit with maturities greater than three months, but less than one year, and certain equity securities. See Note 3 for further information on short-term investments.
Cash held on behalf of others
In our capacity as policy administrator, we collect premiums from members and distributors and, after deducting our earned fees, remit these premiums to our contracted insurance carriers, discount benefit vendors and distributors. We hold the unremitted funds in a fiduciary capacity in bank accounts until they are disbursed, and the use of such funds for certain carriers is restricted. These unremitted amounts are reported as cash held on behalf of others in the accompanying consolidated balance sheets with the related liabilities reported as carriers and vendors payable and commissions payable. Cash held on behalf of others was $4.2 million and $3.8 million as of June 30, 2013 and December 31, 2012, respectively.
Accounts receivable
Accounts receivable represent amounts due to us for premiums collected by a third-party and are generally considered delinquent 15 days after the due date. The underlying insurance contracts are cancelled retroactively if the payment remains delinquent. We have not experienced any credit losses from accounts receivable and have, accordingly, not recognized a provision for uncollectible accounts receivable.
Credit card and ACH transactions receivable
Members may pay their policy premiums to us by credit card or through ACH transfers. The credit card and ACH vendor remits cash for these transactions to us. Credit card and ACH transactions processed by the credit card and ACH vendors or processors, but
11
not yet remitted to us, are recorded as credit card and ACH transactions receivable. A portion of the amounts receivable from these transactions is related to carrier premiums, discount benefit plan fees and third-party commissions. The balance related to carrier premiums, discount benefit plan fees and commissions was $862,000 and $484,000 as of June 30, 2013 and December 31, 2012, respectively, and is included in credit card and ACH transactions receivable on the accompanying balance sheets.
We incur fees for these transactions that are expensed as incurred.
Capitalization of offering costs
Capitalized offering costs are costs directly attributable to the IPO. Prior to the IPO, we had capitalized $3.0 million of offering costs. Upon closing the IPO in February 2013, these costs were netted against the proceeds of the IPO; as such, there was no balance in capitalized offering costs as of June 30, 2013. As of December 31, 2012, the balance of capitalized offering costs was $1.8 million.
Property and equipment
Property and equipment is recorded at cost, less accumulated depreciation, in the accompanying consolidated balance sheets. Depreciation expense for property and equipment was $20,000 and $12,000 for the three months ended June 30, 2013 and 2012, respectively, and $39,000 and $24,000 for the six months ended June 30, 2013 and 2012, respectively and is computed using the
straight-line method over the following estimated useful lives:
Computer equipment
|
|
5 years
|
Furniture and fixtures
|
|
7 years
|
Leasehold improvements
|
|
Shorter of lease term or estimated useful life
|
We periodically review long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. No impairment losses were recognized for the periods presented.
Goodwill and other intangible assets
Goodwill
Under FASB guidance, the process of evaluating the potential impairment of goodwill involves a two-step process and requires significant judgment at many points during the analysis. In the first step, we determine whether there is an indication of impairment by considering relevant qualitative factors or comparing the fair value of the reporting unit to its carrying amount, including goodwill. Our annual impairment test is performed with a measurement date of October 1. If, based on the first step, we determine that there is an indication of goodwill impairment, we assess the impairment in step two in accordance with FASB guidance.
In the second step, we determine the fair value using a combination of three valuation approaches: the cost approach, the market approach and the income approach. The cost approach uses multiples from publicly available transactional data of acquired comparable target companies.
The market approach uses a guideline company methodology, which is based upon a comparison of the reporting unit to similar publicly-traded companies within our industry. We derive a market value of invested capital or business enterprise value for each comparable company by multiplying the price per share of common stock of the publicly traded companies by their total common shares outstanding and adding each companys current level of debt. We calculate a business enterprise multiple based on revenue and earnings from each company, then apply those multiples to our revenue and earnings to calculate a business enterprise value. Assumptions regarding the selection of comparable companies are made based on, among other factors, capital structure, operating environment and industry. As the comparable companies were typically larger and more diversified than our business, multiples were adjusted prior to application to our revenues and earnings to reflect differences in margins, long-term growth prospects and market capitalization.
The income approach uses a discounted debt-free cash flow analysis to measure fair value by estimating the present value of future economic benefits. To perform the discounted debt-free cash flow analysis, we develop a pro forma analysis of the reporting unit to estimate future available debt-free cash flow and discounting estimated debt-free cash flow by an estimated industry weighted average cost of capital based on the same comparable companies used in the market approach. Per FASB guidance, the weighted average cost of capital is based on inputs (e.g., capital structure, risk, etc.) from a market participants perspective and not necessarily from the reporting units perspective. Future cash flow is projected based on assumptions for our economic growth, industry expansion, future operations and the discount rate, all of which require significant judgments by management.
12
After computing a separate business enterprise value under the above approaches, we apply a weighting to them to derive the business enterprise value of the reporting unit. The weightings are evaluated each time a goodwill impairment assessment is performed and give consideration to the relative reliability of each approach at that time. Based on these weightings, we calculated a business enterprise value for the reporting unit. We then added debt-free liabilities of the reporting unit to the calculated business enterprise value to derive an implied fair value of the reporting unit. The implied fair value is then compared to the reporting units carrying value. Upon completion of the analysis in step one as of October 1, 2012, we determined that the fair value of business exceeded its respective carrying value. As such, a step two analysis was not required.
Our goodwill balance arose from the acquisition of the Naylor units of HPI.
The changes in the carrying amounts of goodwill were as follows:
Balance as of January 1, 2012
|
|
$
|
5,906,000
|
|
Goodwill acquired
|
|
|
|
|
Impairment of goodwill
|
|
|
|
|
Balance as of December 31, 2012
|
|
$
|
5,906,000
|
|
Goodwill acquired
|
|
|
|
|
Impairment of goodwill
|
|
|
|
|
Balance as of June 30, 2013
|
|
$
|
5,906,000
|
|
Other intangible assets
Other intangible assets consist of our brand, the carrier network and distributor relationships that were recognized in connection with acquisition purchase accounting, as well as capitalized software and a noncompete agreement. Finite-lived intangible assets are amortized over their useful lives from two to seven years.
Major classes of intangible assets as of June 30, 2013 consisted of the following:
|
Weighted-average
Amortization
|
|
|
Gross Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Intangible
Asset, net
|
|
Brand
|
|
2
|
|
|
$
|
400,000
|
|
|
$
|
350,000
|
|
|
$
|
50,000
|
|
Capitalized software
|
|
5
|
|
|
|
45,000
|
|
|
|
8,000
|
|
|
|
37,000
|
|
Carrier network
|
|
5
|
|
|
|
40,000
|
|
|
|
14,000
|
|
|
|
26,000
|
|
Distributor relationships
|
|
7
|
|
|
|
3,610,000
|
|
|
|
903,000
|
|
|
|
2,707,000
|
|
Noncompete agreement
|
|
5
|
|
|
|
843,000
|
|
|
|
155,000
|
|
|
|
688,000
|
|
Total intangible assets
|
|
6.2
|
|
|
$
|
4,938,000
|
|
|
$
|
1,430,000
|
|
|
$
|
3,508,000
|
|
Major classes of intangible assets as of December 31, 2012 consisted of the following:
|
Weighted-average
Amortization
|
|
|
Gross Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Intangible
Asset, net
|
|
Brand
|
|
2
|
|
|
$
|
400,000
|
|
|
$
|
250,000
|
|
|
$
|
150,000
|
|
Capitalized software
|
|
5
|
|
|
|
45,000
|
|
|
|
4,000
|
|
|
|
41,000
|
|
Carrier network
|
|
5
|
|
|
|
40,000
|
|
|
|
10,000
|
|
|
|
30,000
|
|
Distributor relationships
|
|
7
|
|
|
|
3,610,000
|
|
|
|
645,000
|
|
|
|
2,965,000
|
|
Noncompete agreement
|
|
5
|
|
|
|
843,000
|
|
|
|
70,000
|
|
|
|
773,000
|
|
Total intangible assets
|
|
6.2
|
|
|
$
|
4,938,000
|
|
|
$
|
979,000
|
|
|
$
|
3,959,000
|
|
Amortization expense for the three months ended June 30, 2013 and 2012 was $226,000 and $259,000, respectively, and for the six months ended June 30, 2013 and 2012 was $451,000 and $518,000, respectively.
Accounting for income taxes
Our former operating entity, HPI, was taxed as an S corporation for income tax purposes. Therefore, we were not subject to entity-level federal or state income taxation prior to the IPO. HPIH is currently taxed as a partnership for federal income tax purposes; as a result, the members pay taxes with respect to their allocable shares of each companys respective net taxable income.
13
Following the IPO, HPIH continues to operate in the United States as a partnership for U.S. federal income tax purposes. We are subject to U.S. corporate federal, state and local income taxes that are attributable to HII as reflected in our consolidated financial statements. We use the liability method of accounting for income taxes. Significant management judgment is required in determining the provision for income taxes and, in particular, any valuation allowance that is recorded or released against our deferred tax assets.
We evaluate quarterly the positive and negative evidence regarding the realization of net deferred tax assets. The carrying value of our net deferred tax assets is based on our belief that it is more likely than not that we will generate sufficient future taxable income to realize these deferred tax assets.
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.
Fair value of financial instruments
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. Our short-term investment in a marketable security, available-for-sale is valued based on Level 1 inputs as it is a publicly-traded mutual fund with a quoted price in an active market. Our noncompete obligation is valued based on Level 2 inputs, and primarily valued using nonbinding market prices 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.
14
The carrying amounts of financial assets and liabilities reported in the accompanying consolidated balance sheets for cash and cash equivalents, cash held on behalf of others, other short-term investments, credit card transactions receivable, accounts receivable, advanced commissions, carriers and vendors payable, commissions payable, and accounts payable and accrued expenses as of June 30, 2013 approximate fair value because of the short-term duration of these instruments.
As of June 30, 2013, our short-term investments, which include a marketable security, available-for-sale (a mutual fund) and certificates of deposit with maturities greater than three months to nine months, and our noncompete obligation measured at fair value were as follows:
|
|
|
|
|
Fair Value Measurement as of June 30, 2013
|
|
|
|
Carrying Value as of
June 30, 2013
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable security, available-for-sale
|
|
$
|
14,970,000
|
|
|
$
|
14,970,000
|
|
|
$
|
|
|
|
$
|
|
|
Certificates of deposit
|
|
|
5,521,000
|
|
|
|
5,521,000
|
|
|
|
|
|
|
|
|
|
|
|
$
|
20,491,000
|
|
|
$
|
20,491,000
|
|
|
$
|
|
|
|
$
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncompete obligation, including current portion
|
|
$
|
717,000
|
|
|
$
|
|
|
|
$
|
693,000
|
|
|
$
|
|
|
As of December 31, 2012, our long-term debt and noncompete obligation measured at fair value were as follows:
|
|
|
|
|
Fair Value Measurement as of December 31, 2012
|
|
|
|
Carrying Value as of
December 31, 2012
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt, including current portion
|
|
$
|
3,294,000
|
|
|
$
|
|
|
|
$
|
3,314,000
|
|
|
$
|
|
|
Noncompete obligation, including current portion
|
|
|
781,000
|
|
|
|
|
|
|
|
779,000
|
|
|
|
|
|
|
|
$
|
4,075,000
|
|
|
$
|
|
|
|
$
|
4,093,000
|
|
|
$
|
|
|
Recent Accounting Pronouncements
In December 2011, the FASB issued guidance which requires disclosures of both gross and net information about instruments and transactions eligible for offset as well as transactions subject to an agreement similar to a master netting agreement. This guidance was adopted effective January 1, 2013. As this guidance is limited to presentation only, adoption of this guidance did not have a material impact on our financial position or results of operations.
In July 2012, the FASB issued amended guidance relating to goodwill and other intangible assets which permits an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with GAAP. The more-likely-than-not threshold is defined as having a likelihood of more than 50%. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then no further action is required. This guidance was adopted effective as of January 1, 2013. Since this guidance only changes the manner in which we assess indefinite-lived intangible assets for impairment, adoption did not have a material effect on our financial position or results of operations.
2. Business Acquisitions
Acquisition of Insurance Center for Excellence, LLC and Other Transactions
On June 1, 2012, HPI and TSG Agency, LLC (TSG) acquired ICE. ICE is a call center training facility for the Companys distributors. In connection with the transaction, HPI received an 80% controlling interest in ICE and was required to contribute $80,000 in capital contributions, and TSG received a 20% noncontrolling interest in the business and was required to contribute $20,000 in capital contributions. Subsequent to the initial contributions, HPI contributed an additional $240,000, and TSG contributed an additional $60,000, respectively, to ICE during the year ended December 31, 2012. During the six months ended June 30, 2013, we
15
contributed $40,000 to ICE, and TSG contributed $16,000 to ICE. On June 30, 2013, we purchased TSGs 20% interest in ICE for $90,000 and, as a result, ICE is our wholly-owned subsidiary.
ICE entered into employment agreements with employees of The Amacore Group, Inc. (Amacore) contemporaneously with the June 1, 2012 formation of ICE, and at the date of formation, former Amacore employees comprise the full staff of ICE. ICE additionally assumed a month-to-month lease for space that was occupied by Amacore immediately prior to the formation of ICE.
Concurrent with the formation of ICE, ICE additionally entered into a sublease agreement (Lease Agreement) with Amacore for additional space effective June 1, 2012. Under the Lease Agreement, ICE assumed all rights, responsibilities, obligations, terms and conditions of the original lease, which expires on April 30, 2015. Amacore agreed to transfer to ICE a security deposit previously paid by Amacore of approximately $13,000, and Amacore contributed $15,000 to ICE for the purchase of property and equipment, certain office and computer equipment and rights to certain 800 numbers, to ICE that have minimal value. We are recognizing the consideration provided by Amacore as a lease incentive that is being amortized over the term of the lease on a straight-line basis.
Additionally, concurrent with its June 1, 2012 formation, ICE entered into an Agent Producer Agreement and an Assignment of Commissions Agreement with Amacore (collectively referred to as Agent Agreement). Under the Agent Agreement, ICE assigned its commissions with respect to Assurant dental sales to Amacore in return for production incentives, training, marketing materials, commission payments and reporting, advances on commissions and ongoing sales support.
The transaction with Amacore as described above is a business combination, and no assets or liabilities, including intangible assets or goodwill, were recognized other than those described above.
In March 2013, we paid $5.5 million to enter into an agreement to terminate certain contract rights with TSG. As a result of this transaction, Ivan Spinner, who controls TSG, became an employee of the Company. This transaction was expensed during the six months ended June 30, 2013, and is included within contract termination expense on the accompanying consolidated statement of operations.
3. Short-term investments
As of June 30, 2013, short-term investments consisted of the following:
|
|
Carrying Value as
of June 30, 2013
|
|
|
Fair Value as of
June 30, 2013
|
|
Certificates of deposit (1)
|
|
$
|
5,521,000
|
|
|
$
|
5,521,000
|
|
Marketable security, available-for-sale (2)
|
|
|
14,970,000
|
|
|
|
14,970,000
|
|
|
|
$
|
20,491,000
|
|
|
$
|
20,491,000
|
|
(1)
|
Certificates of deposit have maturities ranging from
greater than three months to nine months.
|
(2)
|
The marketable security is a fixed-income mutual fund classified as short-term due to our intent to invest the balance
into our operations within one year. Cumulative unrealized losses of $30,000 on this security are included in accumulated other comprehensive loss on the accompanying consolidated balance sheet.
|
4. Accounts Payable and Accrued Expenses
As of June 30, 2013 and December 31, 2012, accounts payable and accrued expenses consisted of the following:
|
|
June 30, 2013
|
|
|
December 31, 2012
|
|
Accounts payable
|
|
$
|
372,000
|
|
|
$
|
735,000
|
|
Accrued refunds
|
|
|
457,000
|
|
|
|
467,000
|
|
Accrued wages
|
|
|
203,000
|
|
|
|
90,000
|
|
Accrued professional fees
|
|
|
96,000
|
|
|
|
683,000
|
|
Accrued credit card and ACH fees
|
|
|
62,000
|
|
|
|
56,000
|
|
Accrued interest
|
|
|
20,000
|
|
|
|
12,000
|
|
Deferred salary
|
|
|
|
|
|
|
19,000
|
|
Other accruals
|
|
|
3,000
|
|
|
|
|
|
Total accounts payable and accrued expenses
|
|
$
|
1,213,000
|
|
|
$
|
2,062,000
|
|
16
5. Debt
During September 2011, HPI entered into a bank loan agreement with a principal balance of $4.3 million. The purpose of this loan was to finance a portion of the acquisition of the remaining 50% interest in HPI as discussed in Note 1. At the inception of the loan, borrowings under the facility were secured by all of HPIs assets, including, but not limited to, cash accounts, accounts receivable, and property and equipment. The loan was further secured with a personal unlimited guarantee by Mr. Kosloske and certain real properties owned by Mr. Kosloske. The loan was a self-amortizing five-year loan bearing fixed interest at 5.25% with equal monthly payments of $81,000, which included principal and interest.
There was no interest expense incurred on the loan for the three months ended June 30, 2013 and $17,000 for the six months ended June 30, 2013. Interest expense incurred on the loan was $50,000 and $103,000 during the three and six months ended June 30, 2012, respectively.
In connection with the loan, we recorded deferred financing costs which consisted primarily of consulting and legal fees directly related to the loan. These amounts were amortized over the term of the loan using the effective interest rate method. There was no amortization expense on the deferred financing costs for the three months ended June 30, 2013 and $7,000 for the six months ended June 30, 2013. Amortization expense for the three and six months ended June 30, 2012 was $11,000 and $23,000, respectively.
In February 2013, we repaid the $3.2 million outstanding balance of the loan using a portion of the proceeds of the IPO. The remaining deferred financing costs of $71,000 were written-off to other expense (income) on the accompanying consolidated statement of operations when the loan was repaid.
6. Stockholders Equity
Refer to Note 1 for further information regarding the current capital structure of the Company.
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 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 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).
Holders of each of Class A common stock and Class B common stock are entitled to one vote per share on all matters to be voted upon by the shareholders, 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 June 30, 2013, Class A common stockholders have 38.3% of the voting power in HII and Class B common stockholders have 61.7% of the voting power of 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.
In accordance with the Exchange Agreement, in March 2013, we received $1.3 million in proceeds from the issuance of 100,000 shares of Class A common stock through the over-allotment option. We immediately used the proceeds to acquire Series B Membership Interests, together with an equal number of shares of our Class B common stock, from HPI. These Series B Membership Interests were immediately recapitalized into Series A Membership Interests in HPIH.
Upon completion of the IPO, HII became a holding company, the principal asset of which is our interest in HPIH. All of our business is conducted through HPIH. We are the sole managing member of HPIH and have 100% of its voting rights and control.
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
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
17
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 Stock
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 stockholders for each share of Class A stock, and will not be entitled, for each share of Class B 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.
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 Health Insurance Innovations, Inc. 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.
7. Variable Interest Entities
As of June 30, 2013, we had a variable interest in HPIH, and HPIH is a variable interest entity (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 own less than 50% of the total membership interest, and the other members of HPIH hold no voting rights in HPIH, but own more than 50% of the membership interest. 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 both power and benefits over HPIH. We have the power to direct the activities of HPIH that most significantly impact the entitys economic performance. Pursuant to the Third Amended and Restated Limited Liability Company Agreement of Health Plan Intermediaries Holdings, LLC, we are the sole managing member of HPIH, operate the business, have 100% of the voting power and control the management of HPIH. Our minority 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 100% of the operating income or loss of the VIE.
8. Stock-based Compensation
Effective February 7, 2013, we maintain one stock-based incentive plan, the Health Insurance Innovations, Inc. Long Term Incentive Plan (the LTIP), under which stock options, stock appreciation rights (SARs), restricted shares 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. There are 1,250,000 shares of common stock reserved for issuance under the LTIP.
We recognize expense for stock-based compensation based upon estimated grant date fair value. For grants of options or SARs, we apply the Black-Scholes option-pricing model in determining the fair value of share-based payments to employees. The resulting compensation expense is recognized over the requisite service period. The requisite service period is the period during which an employee is required to provide service in exchange for an award, which often is the vesting period. Compensation expense is recognized only for those awards expected to vest, with forfeitures estimated based on our historical experience and future expectations. All stock-based compensation expense is classified within general and administrative expense in the consolidated statements of operations. None of the stock-based compensation was capitalized during the three and six months ended June 30, 2013.
18
The fair value of SARs granted during the first six months of 2013 was based upon the Black-Scholes option-pricing model. 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. For 2013, the expected stock price volatility was determined using a peer group of public companies within our industry as it is not practicable for the Company to estimate its own volatility due to the lack of a liquid market and active market trades. 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. The Company has not paid dividends in the past and does not currently plan to pay any dividends in the foreseeable future.
The Black-Scholes option-pricing model was used with the following weighted average assumptions:
Risk-free rate
|
|
0.9
|
%
|
Expected life
|
|
4.5 years
|
|
Volatility
|
|
45.5
|
%
|
Expected dividend
|
|
none
|
|
The following table summarizes SARs and restricted shares granted during the three and six months ended June 30 (in thousands):
Three months ended June 30,
|
|
Six months ended June 30,
|
2013
|
|
2012
|
|
2013
|
|
2012
|
SARs
Issued
|
|
Restricted
Shares
Issued
|
|
SARs
Issued
|
|
Restricted
Shares
Issued
|
|
SARs
Issued
|
|
Restricted
Shares
Issued
|
|
SARs
Issued
|
|
Restricted
Shares
Issued
|
|
|
14
|
|
|
|
|
|
150
|
|
543
|
|
|
|
|
The following table summarizes stock-based compensation expense for the three and six months ended June 30, 2013 and 2012 (in thousands):
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2013
|
|
|
2012
|
|
|
2013
|
|
|
2012
|
|
SARs
|
|
$
|
252
|
|
|
$
|
|
|
|
$
|
294
|
|
|
$
|
|
|
Restricted shares
|
|
|
1,675
|
|
|
|
|
|
|
|
2,407
|
|
|
|
|
|
|
|
$
|
1,927
|
|
|
$
|
|
|
|
$
|
2,701
|
|
|
$
|
|
|
The following table summarizes unrecognized stock-based compensation and the remaining period over which such stock-based compensation is expected to be recognized as of June 30, 2013 (in thousands):
|
|
|
|
|
Remaining
years
|
|
SARs
|
|
$
|
510
|
|
|
|
2.8
|
|
Restricted shares
|
|
|
5,089
|
|
|
|
4.0
|
|
|
|
$
|
5,599
|
|
|
|
|
|
These amounts do not include the cost of any additional awards that may be granted in future periods nor any changes in our forfeiture rate. There were no SARs exercised during the three and six months ended June 30, 2013.
We did not have any income tax benefits realized from activity involving stock options, stock appreciation rights, or restricted shares for the three and six months ended June 30, 2013.
19
9. Net loss per Share
The computations of basic and diluted net loss per share attributable to Health Insurance Innovations, Inc. for the three and six months ended June 30, 2013 were as follows (in thousands, except share data):
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30, 2013
|
|
Basic net loss available to common shareholders
|
|
$
|
(404
|
)
|
|
$
|
(4,092
|
)
|
Average sharesbasic
|
|
|
4,766,667
|
|
|
|
4,750,000
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Restricted shares
|
|
|
|
|
|
|
|
|
SARs
|
|
|
|
|
|
|
|
|
Average sharesdiluted
|
|
|
4,766,667
|
|
|
|
4,750,000
|
|
Basic net loss per share attributable to Health Insurance Innovations, Inc.
|
|
$
|
(0.08
|
)
|
|
$
|
(0.86
|
)
|
Diluted net loss per share attributable to Health Insurance Innovations, Inc.
|
|
$
|
(0.08
|
)
|
|
$
|
(0.86
|
)
|
Potential common shares are included in the diluted net loss per share calculation when dilutive. Potential common shares consist of Class A common stock issuable through 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 loss per share because such inclusion would be anti-dilutive (in thousands):
|
|
Three months ended June 30,
|
|
|
Six months ended June 30,
|
|
|
|
2013
|
|
|
2012
|
|
|
2013
|
|
|
2012
|
|
Restricted shares
|
|
|
502
|
|
|
|
|
|
|
|
498
|
|
|
|
|
|
SARs
|
|
|
150
|
|
|
|
|
|
|
|
150
|
|
|
|
|
|
10. Income Taxes
Our former operating entity, HPI, was taxed as an S corporation for income tax purposes. Therefore, we were not subject to entity-level federal or state income taxation prior to the IPO. HPIH and HPIS are currently taxed as partnerships for federal income tax purposes; as a result, the members of HPIH and HPIS pay taxes with respect to their allocable shares of each companys respective net taxable income.
Following the IPO, HPIH and HPIS continue to operate in the United States as partnerships for U.S. federal income tax purposes. We are subject to U.S. corporate federal, state and local income taxes that are reflected in our consolidated financial statements. The effective tax rate for the three and six months ended June 30, 2013 was (18.4)%. We incurred a provision for income taxes of $128,000 and $1.3 million for the three and six months ended June 30, 2013, respectively.
Our effective tax rate includes a rate detriment attributable to the fact that our subsidiaries operate as limited liability companies which are not subject to federal or state income tax. Accordingly, a portion of our earnings or losses attributable to the noncontrolling interest are not subject to corporate level taxes. Additionally, our effective tax rate includes a valuation allowance placed on all of our deferred tax assets, as our belief is more likely than not that our deferred tax assets will not be realized to offset future taxable income.
We project to have a current tax liability for the year, primarily as a result of differences between financial reporting and tax-based reporting for the timing of expense recognition. We do not project that the current tax liability will enable any portion of our deferred tax assets to be realized, and as such, the tax benefit that ordinarily accompanies a deferred tax asset is not available to offset the tax expense from our projected current tax liability. The resulting tax expense correlates with the determination of our effective tax rate
.
As of December 31, 2012, we did not have any balance of gross unrecognized tax benefits, and as such, no amount would favorably affect the effective income tax rate in any future periods. For the three and six months ended June 30, 2013, there was no change to our total gross unrecognized tax benefit. We believe that there will not be a significant increase or decrease to the uncertain tax positions within 12 months of the reporting date.
20
11. Commitments and Contingencies
Leases
We lease office spaces to conduct the operations of HPIH and ICE, which expire in 2017 and 2015, respectively. We also lease certain equipment under operating leases, which expire in 2015. The office space operating lease agreements contain rent holidays and rent escalation provisions. Rent holidays and rent escalation provisions are considered in determining straight-line rent expense to be recorded over the lease term. The difference between cash rent payments and straight-line rent expense was $65,000 and $63,000 as of June 30, 2013 and December 31, 2012, respectively. Total rent expense under all operating leases, which includes equipment, was $61,000 and $32,000 for the three months ended June 30, 2013 and 2012, respectively and $114,000 and $58,000 for the six months ended June 30, 2013 and 2012, respectively and is included in general and administrative expenses in the accompanying consolidated statements of operations.
We also entered into capital lease obligations to finance certain equipment. The leases have terms expiring beginning in 2015. The balance of the equipment and the corresponding liability was $5,000 and $7,000 as of June 30, 2013 and December 31, 2012, respectively. These capital lease obligations are included in property and equipment and other liabilities in the accompanying consolidated balance sheets.
BimSym Agreements
On August 1, 2012, we entered into a software assignment agreement (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 executed Agreement, we purchased the A.R.I.E.S. System for $45,000. The consideration of $45,000 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 five years. After the five-year term, this agreement automatically renews for one-year terms unless 60 days notice is given by us.
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 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 consolidated balance sheets.
Legal Proceedings
As of June 30, 2013, we had no significant outstanding legal proceedings. We are subject to certain legal proceedings and claims that may arise in the ordinary course of business. In the opinion of management, we do not have a potential liability related to any current legal proceedings and claims that would individually, or in the aggregate, have a material adverse effect on our financial condition, liquidity, results of operations, or cash flows.
12. Segments
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, or decision-making group, in deciding how to allocate resources and in assessing our performance. Our chief operating decision-maker is considered to be the chief executive officer (CEO). The CEO reviews our financial information in a manner substantially similar to the accompanying consolidated financial statements. In addition, our operations, revenues, and decision-making functions are based solely in the United States. Therefore, management has concluded that we operate in one operating and geographic segment.
13. Related Party Transactions
Health Plan Intermediaries, LLC
HPI, by virtue of its Series B Membership interests in HPIH, of which we are managing member, is a related party, and the beneficial interests in HPI are held by Mr. Kosloske. During the three months ended June 30, 2013, HPIH paid distributions of $598,000 to HPI for Mr. Kosloskes 2012 and estimated 2013 federal income tax liability, pursuant to the operating agreement entered into by HPIH and HPI. Distributions of $1.5 million, for the six months ended June 30, 2013 include $944,000 of distributions during the three months ended March 31, 2013, all of which were made prior to the IPO. During the three and six months ended June 30, 2012, there were $1.1 million in distributions to HPI.
21
TSG Agency, LLC
In August 2012, we entered into a promissory note with Ivan Spinner, who controls TSG, in the amount of $100,000 for the purpose of funding advanced commissions. The note was non-interest bearing and required equal monthly payments of $25,000 beginning September 20, 2012 and ending December 20, 2012. This loan was modified on October 18, 2012 whereby the November and December payments were deferred to January 2, 2013 and February 1, 2013, respectively. The note was repaid during the first quarter of 2013 and had a balance of $50,000 at December 31, 2012.
On March 14, 2013, the Company terminated its contract rights with TSG for an aggregate cash price of $5.5 million. In conjunction with the transaction, Ivan Spinner joined HII as an employee.
On June 30, 2013, we purchased TSGs interest in ICE for a cash payment to TSG of $90,000. See Note 2 for further information on this transaction.
Tax Receivable Agreement
On February 13, 2013, we entered into a tax receivable agreement with the holders of Series B Membership Interests, which are beneficially owned by Mr. Kosloske. See Note 1 for further description of the tax receivable agreement.
As of June 30, 2013, we have made no such payments under the tax receivable agreement. As of June 30, 2013, we would be obligated to pay Mr. Kosloske $359,000 if our taxes payable on our subsequent annual tax return filings are shown to be reduced as result of an increase in our tax basis due to the issuance of 100,000 shares of Class A common stock subsequent to the IPO under the IPO underwriters option. See Note 6 for further information on this issuance of Class A common stock.
14. Subsequent event
On July 17, 2013, we consummated a Stock Purchase Agreement (the Purchase Agreement) with Joseph Safina, Howard Knaster and Jorge Saavedra (collectively, the Sellers), pursuant to which we acquired from the Sellers all of the outstanding equity of each in Sunrise Health Plans, Inc., a licensed insurance broker, Sunrise Group Marketing, Inc., a call center and sales lead management company, and Secured Software Solutions, Inc., an intellectual property holding company (collectively, Secured), for a cash payment of $10.0 million plus $6.5 million of contingent consideration described below. The funding of the $10.0 million cash portion of the purchase price was provided primarily from net proceeds from the IPO.
The Sellers may also receive contingent cash consideration under an adjustable promissory note us with an initial face amount of $2.75 million and a fair value of approximately $1.8 million, due on June 30, 2015 bearing an interest rate of 5%, payments of which we guarantee. Based upon the level of commission revenue attained by the acquired business operations between July 1, 2013 and June 30, 2015, the principal amount may be decreased if such commission revenue does not increase to a minimum threshold that the parties established (the Threshold) based upon actual commission revenues during the calendar year ended December 31, 2012. Alternatively, in the event growth in commission revenue increases above the Threshold, the notes principal amount may be increased to allow the Sellers to share a portion of the commission growth above the Threshold. We and each of the Sellers also entered into agreements providing for equity earn-out consideration whereby the Sellers have contingent rights to receive up to $3.75 million based on the achievement of certain performance and financial targets over the three years following the closing. The fair value of the equity earn-out is approximately $2.4 million. To the extent that such targets are achieved, such earn-out consideration will be paid in our Class A common stock. The stock price used to determine the number of shares to be issued in connection with such earn-out consideration will be determined at the end of the respective performance periods as set forth in each of the forms of Performance Based Stock Award (A) agreement and Performance Based Stock Award (B) Agreement, copies of which are incorporated by reference to the Current Report on Form 8-K filed on July 23, 2013.
In connection with the Purchase Agreement, on July 17, 2013, we also entered into employment agreements the Sellers, which provide an annual salary of $100,000, $100,000 and $150,000, respectively, and a retention bonus payment of $20,833 to each of them every three months from October 15, 2013 through July 15, 2015.
Related to the acquisition of Secured, during the three months ended June 30, 2013, we recognized $194,000 in transaction costs. There were no integration costs incurred during the three months ended June 30, 2013. Transaction costs were expensed as incurred and are included in general and administrative expenses in the accompanying consolidated statements of operations. We expect to incur additional acquisition related costs in the third quarter of 2013.
As a result of the acquisition of Secured, beginning in the third quarter of 2013, our consolidated results of operations will include the results of Secured. We have not completed a detailed valuation analysis necessary to determine the final fair market
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values of the Secured assets acquired and any related income tax effects and the initial accounting for the business combination is incomplete at this time. We expect to finalize the acquisition accounting related to the transaction during the third quarter of 2013.
Preliminary fair market values of the identifiable assets and goodwill are as follows:
Identifiable assets:
|
|
|
Debt-free working capital
|
$
|
420,503
|
Property and equipment
|
|
121,721
|
Total identified intangible assets
|
|
3,827,000
|
Goodwill
|
|
9,799,880
|
Aggregate purchase price
|
$
|
14,169,104
|
This transaction is expected to provide us with additional benefits such as reduced enterprise risk from enhanced oversight of our marketing function, addition of sales lead management expertise to maximize the number of new insurance policies produced by each dollar invested in sales leads, and opportunities through technological and cost-saving synergies. Pro forma financial information for Secured as of June 30, 2013 and December 31, 2012 and for the periods ended June 30, 2013 and 2012 is currently unavailable. We will furnish such pro forma information pursuant to FASB and SEC guidelines when they become available however, Secureds revenues and net income for the year ended December 31, 2012 were $9.6 million and $321,000, respectively.
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