Notes to Condensed Consolidated Financial Statements
(unaudited)
1. Organization, Basis of Presentation and Summary of Significant Accounting Policies
Health Insurance Innovations, Inc. is a Delaware corporation incorporated on October 26, 2012. 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., to Health Plan Intermediaries, LLC (“HPI”) and Health Plan Intermediaries Sub, LLC (“HPIS”), its consolidated subsidiary, and (2) after the IPO, to Health Insurance Innovations, Inc. and its consolidated subsidiaries. The terms “HIIQ” and “HPIH” refer to the stand-alone entities Health Insurance Innovations, Inc., and Health Plan Intermediaries Holdings, LLC, respectively. The terms “HealthPocket” or “HP” refer to HealthPocket, Inc., our wholly owned subsidiary which was acquired by HPIH on July 14, 2014. The term “ASIA” refers to American Service Insurance Agency LLC, a wholly owned subsidiary which was acquired by HPIH on August 8, 2014. HP, and ASIA are consolidated subsidiaries of HPIH, which is a consolidated subsidiary of HIIQ.
Principles of Consolidation and Basis of Presentation
The accompanying condensed consolidated financial statements for the
three and nine
months ended
September 30, 2018
and
2017
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 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, 2017
.
In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments, which, except as disclosed in the below section titled "Reclassifications," include only normal recurring adjustments, necessary to state fairly the financial position, results of operations, stockholders' equity, and cash flows of the Company. The condensed consolidated results for th
e
three and nine
months ended
September 30, 2018
are not necessarily indicative of the results to be expected for any subsequent interim period or for the year ending
December 31, 2018
.
As an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), we benefit from certain temporary exemptions from various reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements. We have also elected under the JOBS Act to delay the adoption of new and revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates. These exemptions will apply for a period of
five
years following the completion of our IPO on February 13, 2013. The Company will cease to be an emerging growth company as of
December 31, 2018
.
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, 2017
included in our Annual Report on Form 10-K.
Reclassifications
The Company reclassified in-transit credit card and ACH receipts, during the first quarter of 2018, previously included in accounts receivable, net, prepaid expenses, and other current assets on the balance sheet to cash and cash equivalents. The reclassification resulted in a
$1.6 million
increase in cash and cash equivalents and a corresponding decrease in accounts receivable, net, prepaid expense and other current assets as of December 31, 2017 and a decrease of
$217,000
in operating cash flows on the condensed consolidated statement of cash flows for the
nine months ended September 30, 2017
.
The changes described do not affect the condensed consolidated statements of income or stockholders’ equity.
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 unless otherwise noted. 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 November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, 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. The Company has adopted this update during the first quarter of 2018 and has properly reported restricted cash and restricted cash equivalents in our beginning-of-period and end-of-period total cash and cash equivalents balance.
Accounting pronouncements not yet adopted
In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases, to add clarity to certain areas within ASU 2016-02. The effective date and transition requirements will be the same as ASU 2016-02. The Company will evaluate and adopt this ASU in conjunction with ASU 2016-02.
In May 2017, the FASB issued Accounting Standards Update (“ASU”) No. 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting, 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, and will adopt this guidance on December 31, 2018, the date our emerging growth company status expires. We do not expect it to have a significant impact on our consolidated financial statements and disclosures. We will adopt this standard prospectively as required by the standard.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which 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 consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which 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. The Company will adopt this guidance on December 31, 2018, the date our emerging growth company status expires. The standard will be implemented using a retrospective transition method to each period presented, except where it is impracticable, and the amendments for those issues will be applied prospectively. We are currently evaluating the impact of this guidance on our consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which modifies lease accounting for lessees 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 adoption of this standard will impact the Company’s consolidated balance sheet, but the Company is still assessing any other impacts this standard will have on its consolidated financial statements. The Company does not believe that the impact of adopting this standard will be material to the consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) which amends the existing revenue recognition standards. The standard 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 most public entities, the standard became 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. As an emerging growth company, we are required to adopt this guidance on December 31, 2018, the date our emerging growth company status expires.
We will apply the new standard using a modified retrospective approach with the cumulative effect of its application recognized at the date of initial application. We are implementing this new standard in close consultation with our Audit Committee. We have identified our various revenue streams that could be impacted by the new standard and have reviewed individual customer contracts related to these revenue streams to determine material differences between the current and new revenue standards. The new standard will impact the majority of our revenue streams.
In accordance with ASU 2014-09, we will make estimates, including, but not limited to, the estimated revenue to be paid to us over the estimated life of the member policy. Our adoption of ASU 2014-09 will significantly change the timing of our revenue recognition over the course of the year, depending on when applications are approved.
We have identified that we generally have two performance obligations, as defined in the standard, to our customers. These performance obligations typically include:
|
|
2.
|
Bill, Collect, and Support
|
Under current revenue recognition guidance, we generally recognize revenue ratably over the policy period as the members remit their payments. Under the new standard, the Sales and Enrollment performance obligation is considered complete once an application is approved. At the time of approval, we would record the entire amount of revenue allocated to the Sales and Enrollment performance obligation that the Company expects to receive over the life of the insurance policy or discount benefit plan. This estimate will be based on the expected persistency of the underlying insurance policy or discount benefit plan. The remaining performance obligations will be recognized ratably over the estimated life of the insurance policy or discount benefit plan. The Company has not concluded on the treatment of its cost to fulfill and obtain contracts under the new standard.
We anticipate the adoption of the new standard will have a material impact to our opening balance sheet as of January 1, 2018 due to the cumulative effect of adopting the new standard. In addition, we believe our adoption of the new standard will have a material impact on our consolidated balance sheet and consolidated statement of income for the year ended December 31, 2018 however, a reasonable estimate of the quantitative impact of adopting this standard cannot be made at this time.
To prepare for the additional disclosure requirements, we are currently implementing additional tools to support our revenue recognition and data collection processes, which will be in place and effective on December 31, 2018.
The Company has reviewed all other issued, but not yet effective, accounting pronouncements and does not believe the future adoption of any such pronouncements may be expected to cause a material impact on our financial statements.
2. Long-term Advanced Commissions
Long-term advanced commissions as of
September 30, 2018
were
$4.4 million
. There were
no
long-term advanced commissions as of
December 31, 2017
. The Company has made
no
allowance for uncollectible accounts.
3. Goodwill and Intangible Assets
There have been no material changes to Goodwill and Intangible assets from amounts reported in the Company’s Annual Report on Form 10-K at December 31, 2017 except for amortization expense recorded for definite lived intangible assets. Amortization expense for the
three and nine months ended September 30, 2018
was
$464,000
and
$1.4 million
, respectively, compared to
$479,000
and
$1.5 million
for the
three and nine months ended September 30, 2017
, respectively.
4. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consisted of the following as of ($ in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
Carriers and vendors payable
|
$
|
15,412
|
|
|
$
|
14,726
|
|
Commissions payable
|
10,157
|
|
|
8,811
|
|
Accrued compensation and benefits
|
6,549
|
|
|
7,116
|
|
Accrued refunds
|
1,107
|
|
|
1,940
|
|
Accounts payable
|
323
|
|
|
3,725
|
|
Accrued professional fees
|
1,315
|
|
|
820
|
|
Accrued credit card/ACH fees
|
488
|
|
|
483
|
|
Other accrued expenses
|
2,390
|
|
|
2,104
|
|
Total accounts payable and accrued expenses
|
$
|
37,741
|
|
|
$
|
39,725
|
|
As of
September 30, 2018
, included in accrued compensation and benefits is
$3.3 million
related to severance from the termination of the Company's founder, Mr. Kosloske, HP executives, Messrs. Telkamp and Wang, and other Company employees.
5. Debt
There have been no changes to Company debt from amounts reported in the Company’s Annual Report on Form 10-K as of December 31, 2017. As of
September 30, 2018
, we had
no
outstanding balance from draws on the Credit Facility and
$30.0 million
was available to be drawn upon. The Company is in compliance with all debt covenants.
6. Stockholders’ Equity
Except for the items detailed below, there have been no material changes to Stockholders' Equity as reported in the Company’s Annual Report on Form 10-K at December 31, 2017:
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 may have been granted from shares in Treasury.
During the
three and nine months ended September 30, 2018
, there were
45,400
and
83,700
shares, respectively, transferred to Treasury for statutory tax withholding obligations as a result of vested restricted stock awards. During the
three and nine months ended September 30, 2017
, there were
10,300
and
21,900
shares, respectively, transferred to Treasury for statutory tax withholding obligations as a result of vested restricted stock awards. During the
three and nine months ended September 30, 2018
and
2017
, there were
no
shares transferred to Treasury as a result of forfeitures of restricted stock awards.
For the
three and nine months ended September 30, 2018
, there were cash outflows of
$2.2 million
and
$3.5 million
, respectively, with respect to shares redeemed to cover the tax obligations for the settlement of vested restricted stock. During the
three and nine months ended September 30, 2017
, there was
$263,000
and
$448,000
, respectively, of cash outflows with respect to shares redeemed to cover the tax obligations for the settlement of vested restricted stock. The increase in 2018 was due to the accelerated vesting of restricted stock from the termination of the HP executives, Sheldon Wang and Bruce Telkamp, during the
three months ended September 30, 2018
.
Share Repurchase Program
On October 13, 2017, the Company’s Board of Directors authorized a share repurchase program for up to
$50.0 million
of the Company’s outstanding Class A Common Stock.
During the
three and nine months ended September 30, 2018
we repurchased
310,890
and
426,135
shares, respectively, of our registered Class A common stock under the current share repurchase program at an average price per share of
$50.50
and
$45.77
, respectively. During the year ended
December 31, 2017
, we repurchased
222,184
shares of our registered Class A common stock under the current share repurchase program at an average price per share of
$22.15
. During the
three and nine months ended September 30, 2017
there were
no
repurchases made under the previous share repurchase program.
Exchange Agreement
Under the Exchange Agreement, dated February 13, 2013, between the Company and HPI and HPIS (the “Exchange Agreement”), on June 6, 2018, HPI exchanged
1,287,000
shares of Class B common stock of HIIQ and
1,287,000
membership interests of HPIH for
1,287,000
shares of Class A common stock of HIIQ. On that same date, HPIS exchanged
13,000
shares of Class B common stock of HIIQ and
13,000
membership interests of HPIH for
13,000
shares of Class A common stock of HIIQ. Following those exchanges, on June 7, 2018, HPI and HPIS initiated a sale for
1,287,000
and
13,000
shares, respectively, of HIIQ's Class A Common stock and sold such shares of Class A common stock in a transaction under Rule 144 for a price of
$31.01
per share, with the sale settling on June 11, 2018. See Note 10 for further information on the Exchange Agreement.
7. Stock-based Compensation
For stock appreciation rights ("SARs") granted or modified during the
nine months ended September 30, 2018
and
2017
, the Black-Scholes option-pricing model was used with the following weighted average assumptions:
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
Risk-free rate
|
2.3
|
%
|
|
1.7
|
%
|
Expected life
|
0.3 years
|
|
|
4.8 years
|
|
Expected volatility
|
44.6
|
%
|
|
64.0
|
%
|
Expected dividend
|
none
|
|
|
none
|
|
The following table summarizes restricted shares and SARs granted during the
three and nine
months ended
September 30, 2018
and
2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Restricted shares
|
50
|
|
|
—
|
|
|
63
|
|
|
855
|
|
SARs
|
—
|
|
|
100
|
|
|
—
|
|
|
185
|
|
The following table summarizes stock-based compensation expense for the
three and nine months ended September 30, 2018
and
2017
($ in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Restricted shares
|
$
|
4,165
|
|
|
$
|
2,246
|
|
|
$
|
8,940
|
|
|
$
|
3,306
|
|
SARs
|
268
|
|
|
434
|
|
|
1,996
|
|
|
1,116
|
|
Stock options
|
—
|
|
|
3
|
|
|
—
|
|
|
15
|
|
Less amounts capitalized for internal-use software
|
(89
|
)
|
|
—
|
|
|
(433
|
)
|
|
—
|
|
Total
|
$
|
4,344
|
|
|
$
|
2,683
|
|
|
$
|
10,503
|
|
|
$
|
4,437
|
|
The following table summarizes unrecognized stock-based compensation expense and the remaining weighted average period over which such stock-based compensation expense is expected to be recognized as of
September 30, 2018
($ in thousands):
|
|
|
|
|
|
|
|
Unrecognized Expense
|
|
Weighted Average Remaining Years
|
Restricted shares
|
$
|
9,062
|
|
|
1.8
|
SARs
|
1,234
|
|
|
1.9
|
Total
|
$
|
10,296
|
|
|
|
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, 2018
, there were
143,100
and
163,000
SARs exercised, respectively, resulting in an increase of
111,200
and
125,900
issued shares of Class A common stock, respectively. During the
three and nine months ended September 30, 2017
there were
110,500
and
1,400,000
SARs exercised, respectively, resulting in an increase of
89,800
and
1,000,000
shares of issued Class A common stock, respectively. During the
three and nine months ended September 30, 2018
there were
7,500
SARs forfeited. During the
three and nine months ended September 30, 2017
, there were
17,500
outstanding SARs forfeited.
During the
three and nine months ended September 30, 2018
, there were
2,500
and
5,800
options exercised, respectively. During the
three and nine months ended September 30, 2017
there were
10,700
and
29,500
options exercised, respectively. During the
three and nine months ended September 30, 2018
and
2017
there were
no
options forfeited.
During the
three months ended September 30, 2018
, there were
no
restricted stock awards issued for performance shares. During the
nine months ended September 30, 2018
, there were
179,400
restricted stock awards issued for performance shares. These awards were previously granted in which the performance metrics were contractually satisfied during the period.
No
restricted stock awards were issued for performance shares in the
three and nine months ended September 30, 2017
. During the
three and nine months ended September 30, 2018
, there were
35,000
performance shares forfeited. During the
three and nine months ended September 30, 2017
, there were
no
performance shares forfeited.
We recognized income tax benefits from stock-based activity of
$402,000
and
$760,000
for the
three and nine months ended September 30, 2018
, respectively. 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
.
For the
three and nine months ended September 30, 2018
, we capitalized
$89,000
and
$433,000
, respectively, of stock-based compensation expense related to the development of internal-use software.
No
stock-based compensation expense was capitalized during the
three and nine months ended September 30, 2017
. See Note 1 and Note 3 of our Annual Report on Form 10-K for the period ended December 31, 2017 for further information on our internal-use software.
8. Net Income per Share
The computations of basic and diluted net income per share attributable to HIIQ for the
three and nine months ended September 30, 2018
and
2017
were as follows ($ in thousands, except share and per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Basic net income attributable to Health Insurance Innovations, Inc.
|
$
|
3,044
|
|
|
$
|
3,885
|
|
|
$
|
10,056
|
|
|
$
|
14,102
|
|
Weighted average shares—basic
|
12,853,739
|
|
|
11,700,941
|
|
|
12,130,722
|
|
|
10,724,750
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
Restricted shares
|
573,047
|
|
|
466,581
|
|
|
597,012
|
|
|
258,218
|
|
SARs
|
629,038
|
|
|
561,788
|
|
|
568,692
|
|
|
685,583
|
|
Stock options
|
4,629
|
|
|
13,642
|
|
|
6,385
|
|
|
24,204
|
|
Weighted average shares—diluted
|
14,060,453
|
|
|
12,742,952
|
|
|
13,302,811
|
|
|
11,692,755
|
|
Basic net income per share attributable to Health Insurance Innovations, Inc.
|
$
|
0.24
|
|
|
$
|
0.33
|
|
|
$
|
0.83
|
|
|
$
|
1.31
|
|
Diluted net income per share attributable to Health Insurance Innovations, Inc.
|
$
|
0.22
|
|
|
$
|
0.30
|
|
|
$
|
0.76
|
|
|
$
|
1.21
|
|
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,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Restricted Shares
|
50
|
|
|
—
|
|
|
50
|
|
|
405
|
|
SARs
|
—
|
|
|
16
|
|
|
105
|
|
|
—
|
|
Additionally, potential common stock totaling
2,541,667
shares at
September 30, 2018
and
3,841,667
shares at
September 30, 2017
issuable under the exchange agreement were not included in diluted shares because such inclusion would be antidilutive. See Note 7 in our Annual Report on Form 10-K for the year ended
December 31, 2017
for further details on the exchange agreement.
9. 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, 2018
was
26.9%
and
25.4%
, respectively. The effective tax rate for the
three and nine months ended September 30, 2017
was
32.5%
and
16.4%
, respectively. For the
three and nine months ended September 30, 2018
the provision for income taxes was
$1.5 million
and
$4.8 million
, 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. 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. On a standalone basis, the effective tax rate for the
three and nine months ended September 30, 2018
for HIIQ was
15.5%
and
19.3%
, respectively, while the effective tax rate for each of the
three and nine months ended September 30, 2018
for HP was
0.0%
. 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%
, 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, 2018
and
2017
, 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. 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,
2018
and
2017
, respectively. The Company’s 2014 through 2017 tax years remain subject to examination by tax authorities.
10. Commitments and Contingencies
Health Plan Intermediaries, LLC
HPI and its subsidiary HPIS, which are beneficially owned by Mr. Kosloske, a director and former executive officer of the Company, are deemed to be related parties of the Company by virtue of their Series B Membership Interests in HPIH, of which we are the managing member. During the
nine months ended
September 30, 2018
, HPIH paid cash distributions of
$2.8 million
for these entities related to estimated federal and state income taxes, pursuant to the operating agreement entered into by HPIH and HPI. Of these cash distributions,
$638,000
was related to amounts accrued for at
December 31, 2017
and included in Due to member account on the condensed consolidated balance sheet. For the
nine months ended
September 30, 2017
,
$5.3 million
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, 2018
,
no
estimated federal or state income taxes were due.
Tax Receivable Agreement
On February 13, 2013, we entered into a Tax Receivable Agreement (the "TRA") with HPI and HPIS, 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 the Company's obligation and not an obligation of HPIH, and the Company will benefit from the remaining
15%
of any realized cash savings. For purposes of the TRA, cash savings in income tax is computed by comparing our actual income tax liability with our hypothetical liability had we not been able to utilize the tax benefits subject to the TRA itself. The TRA became effective upon completion of the IPO and will remain in effect until all such tax benefits have been used or expired, unless the Company exercises its right to terminate the TRA for an amount based on the agreed payments remaining to be made under the agreement or the Company breaches any of its material obligations under the TRA in which case all obligations will generally be accelerated and due as if the Company had exercised its right to terminate the agreement. Any potential future payments will be calculated using the market value of our Class A common stock at the time of the relevant exchange and prevailing tax rates in future years and will be dependent on us generating sufficient future taxable income to realize the benefit. Payments are generally due under the TRA within a specified period of time following the filing of our tax return for the taxable year with respect to which payment of the obligation arises.
Exchanges of Series B Membership Interests, together with an equal number of shares of our Class B common stock, for shares of our Class A common stock, are expected to increase our tax basis in our share of HPIH’s tangible and intangible assets. These increases in tax basis are expected to increase our depreciation and amortization deductions and create other tax benefits and therefore may reduce the amount of tax that we would otherwise be required to pay in the future. As of
September 30, 2018
, Series B Membership Interests, together with an equal number of shares of Class B common stock have been exchanged for a total of
6,125,000
shares of Class A common stock subsequent to the IPO. As of
September 30, 2018
, as a result of these exchanges, we have recorded a liability of
$27.4 million
pursuant to the TRA, of which
$1.1 million
is included in current liabilities and
$26.3
million
is included in long-term liabilities on the accompanying condensed consolidated balance sheets. 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
September 30, 2018
, we have made
$1.2 million
of cumulative payments under the TRA.
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. In addition to ordinary-course litigation that the Company does not believe to be material, the Company is a party to the proceedings and matters described below:
State Regulatory Examinations
Indiana Multistate Market Conduct Examination
The Company is the subject of a previously disclosed multistate market conduct examination ("MCE") that commenced in April 2016 by the Market Actions Working Group of the National Association of Insurance Commissioners. The MCE, which is led by the Indiana Department of Insurance and is comprised of
43
participating state insurance departments, was initially focused on a review of HCC Life Insurance Company’s sales, marketing, and compliance practices relating to short-term medical plans. The MCE was later expanded to include the Company’s marketing, sales, compliance, and administration activities. During the period from May 2016 through June 2018, the Company was served with requests for information in the form of subpoenas, and the Company responded to the requests and has otherwise been fully cooperating with the examiners, including regular discussions to bring the examination to resolution. The California Department of Insurance published a December 2017 Regulatory Settlement Agreement between HCC and certain states participating in the HCC MCE (and other states have since published the same document); as the Company was not included in that reported settlement, the Company cannot predict whether the reported HCC settlement will affect the resolution or outcome of the examination of the Company. On October 3, 2018 the Company met with the MCE examiners for confidential settlement discussions. These discussions included updated feedback on the results of the examination, and discussion aimed toward potential resolution of the examination. The Company has made what it believes to be an appropriate accrual based on the nature and stage of current discussions with the MCE examiners but the Company is not able to reasonably estimate any additional settlement amount or range of settlement amounts. Under the rules of the MCE, the negotiations remain confidential.
In addition to the MCE, we are aware that other states, including South Dakota are reviewing the sales practices and potential unlicensed sale of insurance by independently owned and operated third-party licensed-agent call centers utilized by the Company, although to the Company’s knowledge, none of these reviews are being conducted directly against the Company or call centers owned by the Company. Other states, including California and Missouri, have requested information of the Company relating to its sales practices, marketing, and other matters.
Massachusetts Regulatory Action
The Company received notification of a civil investigative demand from the Massachusetts Attorney General’s Office (“MAG”) on June 16, 2016. The MAG has requested certain information and documents from the Company which will be used to review the Company’s sales and marketing practices to ensure the Company is in compliance with Massachusetts laws and regulations. Additionally, the Company’s materials and sales and marketing practices are being evaluated in order to ensure that they are neither deceptive nor do they constitute unfair trade practices.
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, 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, a loss arising from the future assessment of a civil penalty against the Company is probable. Notwithstanding, due to the procedural stage of the investigative process, the 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. As of June 30, 2018, there have been no findings of any sort (including findings of breaches or wrongdoing) communicated to the Company by the MAG.
Florida Regulatory Action
On June 11, 2018, the Company received notice that the Florida Office of Insurance Regulation (“OIR”) had conducted an investigation as a result of allegations that the Company’s subsidiary, HealthPocket, Inc. d/b/a AgileHealthInsurance, had advertised inducements in the solicitation of insurance products via an independently owned, third-party website and made allegedly material misstatements on an insurance agency application for licensure. The Company has reviewed the allegations and supporting documents and disagrees with the allegations. The OIR has proposed a settlement stipulation for consent order to resolve the matter. If the Company does not proceed with the settlement stipulation, the OIR has stated it will recommend formal administrative proceedings. The Company currently anticipates that it will be able to resolve the matter amicably with the OIR.
California Regulatory Action
On August 29, 2018, the Company received an Order to Show Cause and Notice of Hearing from the California Department of Insurance alleging that the Company made misleading statements relating to health insurance policies. The Company is actively engaged with the Department to resolve the matter.
We are proactively communicating and cooperating with all regulatory agencies involved in the above-described examinations and actions, and we continue to develop and enhance 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 independent 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.
Claims that involve independently licensed third-party insurance agencies and their agents, and independent insurance carriers, in which the Company is named as a co-defendant
In the case styled as
Charles M. Butler, III and Chole Butler v. Unified Life Ins. Co., et al.
, Case No. 17-cv-00050-SPW-TJC, U.S. District Court for the District of Montana (Billings Div.) (“Butler case”), in which allegations of misrepresentation and claims handling were made against the independent insurance agency and a carrier, the plaintiff also named the Company as a party. The Company is asserting defenses against the claims not limited to that it doesn’t adjudicate claims and made no misrepresentations to Butler. While it is possible that a loss may arise from this case, the amount of such loss is not known or estimable at this time.
In the case styled as
Carter v. Companion Life Insurance Company et al
., Case No. 18-cv-350, U.S. District Court for the District of Alabama (“Carter case”), in which allegations of claims handling were made against the carrier and the plaintiff also named the Company as a party. The Carter case was received on March 20, 2018 and an Amended Complaint was subsequently filed on July 6, 2018. The Company has since moved to dismiss the Amended Complaint, and the parties are awaiting the Court’s ruling. While it is possible that a loss may arise from this case, the amount of such loss is not known or estimable at this time.
The Company has also received claims from insureds relating to lack of carrier coverage, claims handling, and alleged deceptive sales practices relating to carriers with which we do business. In each of these individual insureds’ claims, the Company attempts to dismiss, challenge, or resolve the claims as quickly as possible.
Other
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 were 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 were based substantially on the allegations raised in the short-seller report, contained substantially the same allegations, and alleged that the Company made materially false or misleading statements or omissions relating to regulatory c
ompliance matters, particularly regarding the Company’s application for a third-party administrator license in the State of Florida.
In November and December 2017, the Cioe Investments and Vigorito cases were transferred to the U.S. District Court for the Middle District of Florida, and on December 28, 2017, they were consolidated with the Kavra matter under the case caption,
In re Health Insurance Innovations Securities Litigation
, Case No. 8:17-cv-2186-EAK-MAP (M.D. Fla.). On February 6, 2018, the court appointed Robert Rector as lead plaintiff and appointed lead counsel, and lead plaintiff filed a consolidated complaint on March 23, 2018. The consolidated complaint, which dropped Patrick McNamee as a defendant and added Michael Kosloske as a defendant, largely sets forth the same factual allegations as the initially filed Securities Actions filed in September 2017 and adds allegations relating to alleged materially false statements and omissions relating to the regulatory proceeding previously initiated against the Company by the Montana State Auditor, Commissioner of Securities and Insurance (the “CSI”), which proceeding was dismissed on October 31, 2017 in light of CSI’s decision to join the Indiana Multistate Examination. The complaint also adds allegations regarding insider stock sales by Messrs. Kosloske and Hershberger. The consolidated complaint alleges 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 consolidated complaint, the plaintiffs in the action 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. On May 7, 2018, the Company and the co-defendants filed a motion to dismiss call claims set forth in the complaint, and as of October 29, 2018, the motion had been fully briefed and is awaiting the court’s decision. At this time, the Company cannot predict the probable outcome of this action, and, accordingly,
no
amounts have been accrued in the Company’s condensed consolidated financial statements for this action.
Putative Derivative Action Lawsuits
Two
individuals, Ian DiFalco and Dayle Daniels, filed separate but similar derivative action complaints on April 5 and April 6, 2018, respectively, in the Delaware Court of Chancery naming most of the Company’s directors and executive officers as defendants. The derivative complaints assert alleged violations of Section 14(a) of the Exchange Act, Section 10(b) of the Exchange Act and Rule 10b-5, and Section 20(a) of the Exchange Act, and claims for alleged breach of fiduciary duties, alleged unjust enrichment, alleged abuse of control, alleged gross mismanagement, and alleged waste of corporate assets. The factual allegations in the complaints are based largely on the factual allegations in the above-described consolidated securities class action consolidated complaint and include additional allegations relating to misconduct by third-party call centers utilized by the Company in its operations. The plaintiffs are seeking declaratory relief, direction to reform and improve corporate governance and internal procedures, and an undetermined amount of damages, restitution, interest, and attorneys’ fees and costs. On June 5, 2018, the court entered a stipulation and order staying the litigation pending resolution of the above-described securities litigation (In re Health Insurance Innovations Securities Litigation), whether by dismissal with prejudice or entry of final judgment. Defendants intend to vigorously defend against these claims. However, at this time, the Company cannot predict the probable outcome of these actions, and, accordingly,
no
amounts have been accrued in the Company’s condensed consolidated financial statements for this action.
Telephone Consumer Protection Act
The Company has received a number of private-party claims relating to advertising activities allegedly conducted by independently owned and operated licensed-agent distributors, who are only associated with the Company by their use of our technology and billing platform. Generally, these claims assert that the Company violated the Telephone Consumer Protection Act ("TCPA"), although we believe that the Company does not engage in such activities. In fact, the Company maintains internal and external compliance staff and processes to monitor distributor compliance. Historically, the Company has been successful at obtaining dismissals or settling the claims for immaterial amounts. In the previously reported case of Hicks, the Company was dismissed from the case with prejudice without any finding of liability and without it having to make settlement payment on its behalf. As part of the complete dismissal and resolution of the case in the Company’s favor, Hicks affirmatively stated that the Company made none of the alleged telephone calls as originally asserted in the complaint and had no liability or responsibility of the alleged marketing activities. The Company continues to defend itself through procedural motions in
two
other cases filed by what we have determined to be serial-professional plaintiffs known as Craig Cunningham and Kenneth Moser. In Cunningham, the Company has been successful at having the case dismissed twice, including receiving comments from the Federal Court encouraging Mr. Cunningham not to refile. Contrary to that suggestion, Mr. Cunningham refiled his case again and the Company has responded with another motion to dismiss. Moser, who like Cunningham, has been a plaintiff in hundreds of similar cases against companies nationwide. Similarly, the Company has received claims for alleged TCPA violations from other claimants, the majority of which are not lawsuits. The Company believes many of these individuals to be professional plaintiffs and not common consumers. The Company maintains an internal legal department that reviews these claims as they arise, coordinates the Company’s response to such, and supports outside counsel when litigation defense is required. While these types of claims have previously settled, been dismissed, 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 commonly uses outside legal counsel to defend against such claims and requires that the independently owned, licensed-agent distributors who are related to any such claims provide indemnification and reimbursement to the Company for the costs associated with these Claims.
Other matters
We enter into agreements in the ordinary course of business that may require us to indemnify the other party for claims brought by a third-party. From time to time, we have received requests for indemnification. Presently the Company is managing and responding to both formal demands and informal requests for indemnification from a number of carriers related to the MCE, states' investigations into carriers relating to agent licensing, and the TCPA claims identified above. Management cannot reasonably estimate any potential losses, but these claims could result in a material liability for us.
11. Related Party Transactions
There have been no material changes to the Related Party Transactions disclosures made in our Annual Report on Form 10-K for the period ended December 31, 2017, except for those noted in Note 6 and Note 10 above related to required payments under the TRA, exchanges under the Exchange Agreement, and the HPIH and HPI Operating Agreement.