Our principal executive offices are located at 907 NW Ballard Way, Seattle, Washington. The lease for our principal office is for 37,500 square feet and expires in August 2016. We also occupy 12,000 square feet of office space in Seattle, Washington pursuant to a lease that expires in March 2016 and 1,600 square feet of office space in Vancouver, British Columbia pursuant to a lease that expires in March 2017.
During 2015, the Company entered into a lease agreement for a building located in Seattle, Washington. The initial 10-year term of the lease is expected to commence in the second or third quarter of 2016 and will expire in 2026.
The following selected consolidated financial and other data should be read with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The selected consolidated statements of operations data for the years ended December 31, 2015, 2014 and 2013 and the consolidated balance sheet data as of December 31, 2015 and 2014 are derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected consolidated statements of operations data for the years ended December 31, 2012 and 2011 and the consolidated balance sheet data as of December 31, 2013, and 2012 and 2011 are derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results to be expected in any future period.
Monthly adjusted revenue per pet is calculated in part based on adjusted revenue, a non-GAAP financial measure, that we define as revenue from our subscription business segment excluding sign-up fee revenue and the change in deferred revenue between periods. For more information about adjusted revenue and a reconciliation of revenue to adjusted revenue, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Non-GAAP Financial Measures.”
We provide a medical insurance plan for cats and dogs throughout the United States, Canada and Puerto Rico. Our data-driven, vertically-integrated approach enables us to provide pet owners with what we believe is the highest value medical plan for their pets, priced specifically for each pet’s unique characteristics. Our growing and loyal member base provides us with highly predictable and recurring revenue. We operate our business similar to other subscription-based businesses, with a focus on maximizing the lifetime value of each pet while sustaining a favorable ratio of lifetime value relative to acquisition cost.
We generate leads for our subscription business through both third-party referrals and online member acquisition channels, which we then convert into members through our website and contact center. Veterinary practices represent our largest referral source. We engage a national referral network of independent contractors who are paid fees based on activity in their regions, which we refer to as our Territory Partners. Our Territory Partners are dedicated to cultivating direct veterinary relationships and building awareness of the benefits that our medical plan offers veterinarians and their clients. Veterinarians then educate pet owners, who visit our website or call our contact center to learn more about, and potentially enroll in, our medical plan. Our online member acquisition channels serve as important resources for pet owner education and drive new member leads and conversion. We also receive a significant number of new leads from existing members adding pets and referring their friends and family members. We constantly evaluate the effectiveness of our member acquisition channels and marketing initiatives based upon their return on investment, which we measure by comparing the ratio of the lifetime value of a pet generated through each specific channel or initiative to the related pet acquisition cost.
We believe that one of the key operating drivers for any subscription business is the amount of sales and marketing expenses incurred to drive new customer acquisition, which is typically evaluated in relation to lifetime value. In order to assess this metric, we regularly review a number of financial and operating metrics, including per pet unit economics, to evaluate our subscription business, determine the allocation of resources and make decisions regarding business strategy.
Lifetime value of a pet. Lifetime value of a pet (LVP) is calculated in part based on gross profit from our subscription business segment for the 12 months prior to the period end date excluding stock-based compensation expense related to cost of revenue from our subscription business segment, sign-up fee revenue and the change in deferred revenue between periods, multiplied by the implied average subscriber life in months. Implied average subscriber life in months is calculated as the quotient obtained by dividing one by one minus the average monthly retention rate. We monitor LVP to assess how much lifetime value we might expect from new pets over their implied average subscriber life in months and to evaluate the amount of sales and marketing expenses we may want to incur to attract new pet enrollments.
Average pet acquisition cost. Pet acquisition cost (PAC) is calculated as net acquisition cost divided by the total number of new pets enrolled in that period. Net acquisition cost, a non-GAAP financial measure, is calculated in a reporting period as sales and marketing expenses, excluding stock-based compensation, offset by sign-up fee revenue and other business segment sales and marketing expenses. We offset sales and marketing expenses with sign-up fee revenue since it is a one-time charge to new members used to partially offset initial setup costs, which are included in sales and marketing expenses. We monitor average pet acquisition cost to evaluate the efficiency of our sales and marketing programs in acquiring new members and measure effectiveness using the ratio of our lifetime value of a pet to average pet acquisition cost.
Adjusted EBITDA. Adjusted EBITDA is a non-GAAP financial measure that we define as net loss excluding stock-based compensation expense, depreciation and amortization expense, interest income, interest expense, change in fair value of warrant liabilities and income tax (benefit) expense. For more information about adjusted EBITDA and a reconciliation of net loss to adjusted EBITDA, see Non-GAAP Financial Measures below.
fluctuations caused by changes in our stock price. We believe this allows us to calculate and present adjusted revenue, acquisition cost, and net acquisition cost and the related financial measures we derive from them, as well as adjusted EBITDA, in a consistent manner across periods. Our non-GAAP financial measures and the related financial measures we derive from them are important tools for financial and operational decision-making and for evaluating our own operating results over different periods of time.
The following table reflects the reconciliation of adjusted revenue to revenue:
Other business segment. Our other business segment includes revenue and expenses related to our writing of policies for an unaffiliated general agent. This relationship can be canceled by the unaffiliated general agent within 360 days’ notice and we are unlikely to be able to replace it with a similar contract quickly, if at all. A cancellation of this contract would result in the policies and revenue being run off over a period of 12 months and could have a material impact on our results of operations. Our other business segment also includes revenue and expenses related to policies written under a federal government program. We may enter into additional relationships to the extent we believe they will be profitable to us, which could also impact our operating results.
We generate revenue in our other business segment primarily from writing policies which are not directly marketed to consumers. Revenue from our other business segment is recognized on a pro rata basis over the enrollment term for each policy.
Claims expenses include claims incurred, the cost of personnel administering the claims and providing member service relating to the claims and other operating expenses directly or indirectly related to claims administration. Claims incurred are the claims approved for payment plus an accrual for claims incurred that have not yet been submitted or approved for payment. This accrual is based on our historical experience and developments in claims frequency and severity and the cost of veterinary care, and also includes the cost of administering such claims.
For both our subscription business and our other business segments, we generally expect our cost of revenue to remain relatively constant as a percentage of revenue, although there may be some periodic variability due to a number of factors including the rate of claims occurrences during such periods. Claims expenses as a percentage of our subscription business revenue may increase over time as part of our strategy to return more value to our members to further enhance our member experience, retention rates and lifetime value of a pet. We currently expect that, in the long-term, such increases generally would be offset by economies of scale in our other cost of revenue.
General and administrative expenses consist primarily of personnel costs and related expenses for our finance, actuarial, human resources, regulatory, legal, general management functions, as well as facilities and professional services. We expect general and administrative expenses to decrease as a percentage of revenue as we begin to experience scale in our fixed costs.
In 2015, the prior period financial data and metrics have been recast to reflect the movement of certain pets from the subscription business segment to the other business segment. Refer to “-Basis of Presentation” for further details.
Year ended December 31, 2014 compared to year ended December 31, 2013. Total revenue increased by $32.1 million to $115.9 million for the year ended December 31, 2014, or 38%. Revenue for our subscription business segment increased by $27.1 million to $103.5 million for the year ended December 31, 2014, or 35%. This increase in subscription business revenue was primarily due to a 28% increase in total subscription pets enrolled as of December 31, 2014 compared to December 31, 2013. Adjusted revenue per pet increased from $42.56 to $44.14, or 4%, for the same period due to pricing increases. The impact of the increase was partially offset by an approximate $2.1 million impact of foreign exchange rates on our Canadian revenue. Revenue from our other business segment increased $4.9 million to $12.4 million for the year ended December 31, 2014, as a result of the remaining policies written for the unaffiliated general agent being transferred to us from its previous underwriting company, whereas only a portion of such policies had been transferred from its previous underwriting company during the year ended December 31, 2013. Included in the increase in our other business revenue is $0.9 million related to medical plans under a federal government program that started in March 2014.
Year ended December 31, 2014 compared to year ended December 31, 2013. Cost of revenue for our subscription business segment was $85.2 million, or 82% of revenue, for the year ended December 31, 2014, compared to $61.4 million, or 80% of revenue, for the year ended December 31, 2013. This $23.8 million increase in subscription cost of revenue was the result of an increase in claims expenses, which were 72% of revenue for the year ended December 31, 2014, compared to 70% of revenue for the year ended December 31, 2013. We have in the past and expect in the future to experience fluctuations in the claims ratio from quarter to quarter. During 2014, the claims expense ratio was higher than our historical average due to a higher frequency of claims than previous periods, which primarily was driven by the implementation of several key initiatives designed to improve our member experience. In addition, compensation expense and related costs increased by $1.7 million due to a 43% increase in employee headcount to service our growth and improve our member experience.
Cost of revenue for our other business segment increased $4.1 million to $10.9 million for the year ended December 31, 2014. This increase is primarily a result of having the full business for the unaffiliated general agent for the entire twelve months of 2014, as well as the addition of a government program that began in 2014.
Year ended December 31, 2015 compared to year ended December 31, 2014. Other expense, net for the year ended December 31, 2015 decreased $4.9 million to $0.3 million. This was primarily due to a decrease in interest expense associated with the repayment of debt and the expensing of unamortized debt discounts associated with the repayment of debt in 2014, partially offset by the revaluation of warrants classified as liabilities which resulted in other income in the prior year.
In 2015, the prior period financial data and metrics have been recast to reflect the movement of pets from the subscription business segment to the other business segment. Refer to “-Basis of Presentation” for further details.
Cash and investments held by our insurance subsidiaries, American Pet Insurance Company (APIC) and Wyndham Insurance Company (SAC) Limited (WICL) Segregated Account AX, are subject to certain capital and dividend rules and regulations as applicable within the jurisdictions in which they are authorized to operate. For more information on this change, see “-Regulation”.
In April 2007, we entered into a loan and security agreement with Square 1 Bank (Square 1), which we amended and restated in August 2012 and most recently amended in December 2014. We refer to this amended and restated loan and security agreement as our Square 1 credit facility. The Square 1 credit facility provides for a revolving line of credit, under which we may take advances up to $20.0 million. The maximum amount for borrowing under the Square 1 credit facility, inclusive of any amounts outstanding under the revolving line of credit and the term loan, is the lesser of $20.0 million or the total amount of cash and securities held by our subsidiary, American Pet Insurance Company, less up to $1.6 million for obligations we may have outstanding from Square 1 for other ancillary services, including our $1.1 million letter of credit.
Interest on the revolving line of credit accrues at a variable annual rate equal to the greater of 5.0% or 1.5% plus the prime rate. The revolving line of credit matures in July 2017, at which time it will need to be renewed or all amounts outstanding under it, including accrued interest, will become immediately due and payable.
Our obligations under the Square 1 credit facility are secured by substantially all of our assets and a pledge of certain of our subsidiaries’ stock. As of December 31, 2015, we had no aggregate borrowings outstanding and under the Square 1 credit facility.
As of December 31, 2015, our insurance entities, APIC and Wyndham Insurance Company (SAC) Limited (WICL) Segregated Account AX, held $27.7 million in investments and $9.8 million in other current assets, including $1.7 million held in cash and cash equivalents to be used for operating expenses of our insurance subsidiaries. Most of the assets in APIC and WILC Segregated Account AX are subject to certain capital and dividend rules and regulations prescribed by jurisdictions in which they are authorized to operate. As of December 31, 2015, total assets and liabilities held outside our insurance entities totaled $33.5 million and $7.8 million, respectively, including $9.8 million of cash and cash equivalents that are segregated from other operating funds and are held in trust for the payment of claims on behalf of our insurance subsidiaries.
To comply with these regulations and contractual obligations of APIC and WICL Segregated Account AX, we may be required to maintain capital that we would otherwise invest in our growth and operations, which may require us to modify our operating plan or marketing initiatives, delay the implementation of new solutions or development of new technologies, decrease the rate at which we hire additional personnel and enter into relationships with Territory Partners, incur indebtedness or pursue equity or debt financings or otherwise modify our business operations.
The majority of our investments are held by our insurance entities to satisfy risk-based capital requirements of the National Association of Insurance Commissioners (NAIC). The NAIC requirements provide a method for analyzing the minimum amount of risk-based capital (statutory capital and surplus plus other adjustments) appropriate for an insurance company to support its overall business operations, taking into account the risk characteristics of the company’s assets, liabilities and certain other items. An insurance company found to have insufficient statutory capital based on its risk-based capital ratio may be subject to varying levels of additional regulatory oversight depending on the level of capital inadequacy. APIC must hold certain capital amounts in order to comply with the statutory regulations and, therefore, we cannot use these amounts for general operating purposes without regulatory approval. As our business grows, the amount of capital we are required to maintain to satisfy our risk-based capital requirements may increase significantly. As of December 31, 2015, APIC was required to maintain at least $24.5 million of risk-based capital to avoid this additional regulatory oversight. As of that date, APIC maintained $26.1 million of risk-based capital. The NY DFS may increase the required levels of risk-based capital in the future, and we anticipate that we will need to maintain greater amounts of risk-based capital if our pet enrollment continues to grow.
New York laws also restrict the ability of APIC to pay dividends to our parent holding company. The dividend restrictions are based in part on the prior year’s statutory income and surplus. In general, dividends up to specified levels are considered ordinary and may be paid without prior approval. In general, dividends or distributions that, in the aggregate in any 12-month period exceed the lesser of (i) 10% of surplus as of the preceding December 31 or (ii) the insurer’s adjusted net investment income for such 12-month period ended the preceding December 31, not including realized capital gains, are subject to approval by regulatory authorities. As of December 31, 2015, less than $0.1 million was able to be paid in the form of a dividend from APIC to our parent holding company without prior approval from regulatory authorities.
Net cash used in operating activities for the year ended December 31, 2015 consisted of our net loss of $17.2 million reduced by non-cash expenses, including stock-based compensation of $3.0 million and depreciation and amortization of $2.5 million and a $1.3 million change in operating assets, which were primarily driven by an increase in claims paid, increased spend on marketing and technology initiatives, increased payables due to timing of payments, as well as an increase in prepaid assets due to prepayments made for benefits and a new billing system. These increases in cash used in operating activities were partially offset by increased revenue due to enrollment growth and higher monthly adjusted revenue per pet.
Net cash used in operating activities for 2014 consisted of our net loss of $21.2 million reduced by non-cash expenses, including stock-based compensation of $4.1 million and the amortization of the debt discount of $5.0 million as well as changes in our operating assets and liabilities of $1.1 million, which were primarily driven by an increase in claims paid, increased spend on marketing and technology initiatives, as well as an increase in prepaid assets due to advance payment insurance. These increases in cash used in operating activities were partially offset by increased revenue due to enrollment growth and higher adjusted revenue per pet.
For 2013, net cash provided by financing activities consisted of the incurrence of an aggregate of $20.0 million of borrowings under our revolving line of credit and term loans. Of this amount, $3.0 million was designated as restricted cash at December 31, 2013. In addition, we received $0.6 million in proceeds from the exercise of stock options.
We enter into long-term contractual obligations and commitments in the normal course of business, primarily debt obligations and non-cancellable operating leases. Our contractual cash obligations as of December 31, 2015 are set forth below (in thousands):
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities, revenue and expenses at the date of the financial statements. Generally, we base our estimates on historical experience and on various other assumptions in accordance with GAAP that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.
In addition to the assumptions used in the Black-Scholes-Merton option-pricing model, the amount of stock option expense we recognize in our consolidated statements of operations includes an estimate of stock option forfeitures. Estimated forfeitures did not have a material impact on our assumptions in 2015, 2014 or 2013.
We use the liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect when such assets and liabilities are recovered or settled. We determine deferred tax assets including net operating losses (NOLs) and liabilities, based on temporary differences between the book and tax bases of assets and liabilities. We believe that it is currently more likely than not that our deferred tax assets will not be realized, and as such, a full valuation allowance is required. In addition, utilization of NOLs and credits to offset future income subject to taxes may be subject to substantial annual limitations due to the “change in ownership” provisions of the Internal Revenue Code of 1986, and similar state provisions. We have not performed a significant analysis to determine whether a qualifying change in ownership that would limit the utilization of our NOLs has taken place.
As of December 31, 2015 and 2014, our reserve for claims incurred but not yet reported was $6.3 million and $5.1 million, respectively. We believe the amount of our claims reserve as of December 31, 2015 is adequate and we do not believe that there are any reasonably likely changes in the facts or circumstances underlying key assumptions that would result in the reserve for claims being insufficient in an amount that would have a material impact on our reported results, financial position or liquidity. The ultimate liability, however, may be in excess of or less than the amount we have reserved. During 2015, 2014 and 2013, we experienced actual claims that were below our estimate for prior year reserves by less than $0.1 million, $0.5 million and $0.1 million, respectively. Historically, approximately 95% of claims have been settled within three months of the claim date.
We have audited the accompanying consolidated balance sheets of Trupanion, Inc. as of December 31, 2015 and 2014, and the related consolidated statements of operations, comprehensive loss, changes in redeemable convertible preferred stock and stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2015. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
The Company provides medical insurance plans for cats and dogs throughout the United States, Canada and Puerto Rico. The Company’s data-driven, vertically-integrated approach enables us to provide pet owners with what we believe is the highest value medical plan for their pets, priced specifically for each pet’s unique characteristics. We strive to operate the business similar to other subscription-based businesses, with a focus on maximizing the lifetime value of each pet while sustaining a favorable ratio of lifetime value relative to acquisition cost.
Certain prior year amounts have been reclassified within the Company’s consolidated financial statements from their original presentation to conform with the current period presentation. In addition, amounts in note 13 related to segments have been recast to reflect a change in the composition of Company’s segments as described in note 13.
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingencies and the reported amounts of revenue and expenses. Significant items subject to such estimates and assumptions include the valuation of deferred tax assets, stock-based compensation, claims reserve, useful lives of software developed for internal use and income tax uncertainties. Actual results could differ from the estimates used in preparing the consolidated financial statements.
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. At times, cash on deposit may be in excess of the applicable federal deposit insurance corporation limits.
Receivables are comprised of trade receivables and other miscellaneous receivables. As of December 31, 2015 and 2014, receivables included $7.2 million and $6.8 million, respectively, for one-year policies written by an unaffiliated general agent.
The Company incurs certain costs related to the successful acquisition of new and renewal customer contracts, which are capitalized. These costs include premium taxes, commissions, and referral fees that directly relate to the successful acquisition of new or renewal customer contracts. Deferred acquisition costs are included in prepaid expenses and other assets on the consolidated balance sheet and are amortized over the related policy term to the applicable financial statement line item, including sales and marketing expenses and other cost of revenue. Total deferred acquisition costs for the years ended December 31, 2015, 2014 and 2013 are summarized below (in thousands):
Premiums and discounts on fixed maturity securities are amortized or accreted over the life of the security. Such amortization expense and accretion is included in interest income. Interest income is recognized in other (income) expense, net when earned.
Long-lived assets, such as property and equipment and definite lived intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
The claims reserve includes unpaid claims and claims adjustment expenses, which includes an estimate, based on past experience, for claims incurred but not reported. Such liabilities are necessarily based on assumptions and estimates, and while management believes the amount is adequate, the ultimate liability may be in excess of or less than the amount provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed, and any adjustments are reflected in the period in which they become known.
Other cost of revenue for the subscription business segment includes direct and indirect member service expenses, renewal fees, credit card transaction fees and premium tax expenses. Other cost of revenue for the other business segment includes the commission the Company pays to the unaffiliated general agent and premium taxes on other policies in this segment.
For the Company’s Canadian business, all plans are written by Omega General Insurance Company (Omega) and the risk is assumed by the Company through a fronting and reinsurance agreement. Premiums are recognized and earned pro rata over the terms of the related customer contracts. Premiums recognized from the agreement in 2015, 2014 and 2013 were $30.9 million, $29.1 million and $24.7 million, respectively and deferred revenue relating to this arrangement at December 31, 2015 and 2014 was $0.9 million and $0.9 million, respectively. Reinsurance revenue was 21%, 25% and 29% of total revenue in 2015, 2014 and 2013, respectively. Cash designated for the purpose of paying claims related to this reinsurance agreement was $2.0 million and $1.7 million at December 31, 2015 and 2014, respectively. As required by the Office of the Superintendent of Financial institutions regulations related to the Company’s reinsurance agreement with Omega General Insurance Company, the Company is required to fund a Canadian Trust account with the greater of CAD $2.0 million or 115% of unearned Canadian premium plus 15% of outstanding Canadian claims, including all incurred by not reported claims.
Advertising costs are expensed as incurred, with the exception of television advertisements, which are expensed for the first time each advertisement is aired. Advertising costs amounted to $5.3 million, $3.2 million and $0.7 million, in 2015, 2014 and 2013, respectively.
In May 2015, the FASB issued an ASU amending short-term insurance contract disclosures and requiring more detailed disclosures to enable users of financial statements to understand information relating to liabilities for unpaid claims and claims adjustment expenses. Additionally, the amendments will also require insurance entities to disclose information about significant changes in methodologies and assumptions used to calculate these liabilities. This guidance is effective for annual reporting periods beginning after December 15, 2015 and interim periods beginning after December 15, 2016. Early adoption of this guidance is permitted, and must be applied retrospectively by providing comparative disclosures for each period presented. The Company plans to adopt this guidance as of December 31, 2016.
exchangeable shares, unvested restricted stock and stock options. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company’s net loss position.
The Company capitalized interest of $0.2 million and $0.1 million in 2014 and 2013, respectively, related to software developed for internal use.
The Company acquired an insurance company in 2007, which originally included licenses in 23 states. These licenses were valued at $4.8 million. The Company is currently licensed in all 50 states, the District of Columbia and Puerto Rico. Most licenses are renewed annually upon payment of various fees assessed by the issuing state. Renewal costs are expensed as incurred. This is considered an indefinite-lived intangible asset given the planned renewal of the certificates of authority and applicable licenses for the foreseeable future. No impairments have been recorded on this asset as of December 31, 2015.
A rollforward of activity in liabilities valued using Level 3 inputs is as follows (in thousands):
Changes in fair value upon remeasurement are recorded in other (income) expense, net on the consolidated statement of operations.
The Company’s accounting policy is to recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer. There were no transfers between levels for the twelve months ended December 31, 2015 and 2014.
Warrant liabilities: These liabilities are valued using the Black-Scholes-Merton option-pricing model using certain unobservable inputs that are estimated by the Company. These inputs include a measure of volatility using an average of peer companies’ publicly traded stock volatility, expected dividend payments based on management’s assertion that no dividends will be paid in the near term, the remaining contractual term and a discount rate using an average equivalent bond yield calculation. The range of inputs used is as follows:
During 2015, the Company invested $0.3 million in DataPoint, LLC in exchange for 300,000 units of Series A preferred stock resulting in a 13% equity interest. Additionally, if certain revenue and EBIT (Earnings before interest and taxes) targets are not met as of April 1, 2017, the Company’s ownership interest will increase proportionally by the amount by which the targets were missed, up to a maximum of 28%. The Company’s equity interest in DataPoint, LLC is accounted for under the equity method as the Company has the ability to exert significant influence. The equity method investment balance is adjusted each period on a one quarter lag to recognize the proportionate share of net income or loss, including adjustments to recognize certain differences between the carrying value and the equity in net assets.
The Company has entered into agreements for strategic marketing initiatives, as well as with independent contractors to provide services for a period of time. Future commitments related to these contracts are as follows (in thousands):
The Company is involved from time to time in claims, regulatory examinations and litigation, including the following:
The Company received an inquiry from the Washington State Office of the Insurance Commissioner (OIC) in December 2012 concerning whether one of its subsidiaries was properly licensed, and whether certain of its employees were properly licensed, under Washington law. A regulatory examination took place during the third and fourth quarters of 2014. On September 22, 2015, the OIC issued a detailed report and the Company timely issued a response during the fourth quarter of 2015. As of December 31, 2015 and 2014, the Company had accrued liabilities of $0.4 million and $0.2 million, respectively, for this matter. Adverse outcomes beyond recorded amounts are reasonably possible. At this stage in the matter, however, the Company is unable to estimate a possible loss or range of possible loss beyond amounts accrued.
The decrease in incurred claims for prior years in the year ended December 31, 2015, December 31, 2014 and December 31, 2013 is primarily due to less claims than expected relating to prior year claims.
On December 23, 2013, the Company obtained a term loan in an aggregate principal amount of $12.0 million. This note was entered into at a discount of $3.8 million related to the issuance of warrants being deducted from the principal amount. On July 2, 2014, the Company entered into an amended and restated credit agreement in relation to this existing $12.0 million term loan for a secured subordinated term loan totaling $29.0 million, which reflected an increase of $17.0 million from the prior agreement. The amended principal amount was entered into at an additional discount of $1.1 million as a result of the issuance of warrants. The term loan bore a fixed interest rate of 11.0% per year and was due on the earlier of three years from the issue date or certain triggering events, including a qualifying IPO, which would result in a 1.5% prepayment premium on the $17.0 million increase related to the amendment. The $29.0 million term loan was repaid in full on July 23, 2014, including $0.9 million in accrued interest and a prepayment fee of $0.3 million. The unamortized discount on debt totaling $4.4 million was included in interest expense in the consolidated statement of operations.
The grant date fair value of stock option awards are estimated on the date of grant using the Black-Scholes-Merton option-pricing model. Valuation assumptions for the years ended December 31, 2015, 2014 and 2013 are presented in the following table:
Stock option activity for the years ended December 31, 2015, 2014 and 2013 was as follows:
The weighted-average grant date fair value of stock options granted and the fair value of options vested were as follows for the years ending December 31, 2015, 2014, and 2013:
As of December 31, 2015, the Company had unrecognized stock-based compensation expense of $5.5 million, which is expected to vest over a weighted-average period of approximately 2.6 years. As of December 31, 2015, the Company had 1,257,414 unvested stock options and 472,384 restricted stock awards that are expected to vest. No net tax benefits related to the stock-based compensation costs have been recognized since the Company’s inception.
On July 23, 2014 the Company completed an IPO pursuant to which 8,193,750 shares of common stock were sold to the public at a price of $10.00 per share. The Company received net proceeds of approximately $72.8 million from the IPO. Upon the closing of the IPO, all shares of outstanding convertible preferred stock and exchangeable shares automatically converted into
14,944,945 and 2,247,130 shares of common stock, respectively. If this transaction had taken place on January 1, 2014, the Company’s weighted-average shares outstanding for the twelve months ended December 31, 2014 would have been 27,067,167.
As of December 31, 2015, the Company’s insurance subsidiary maintained $26.1 million of statutory capital and surplus which was above the required amount of $24.5 million of statutory capital and surplus to avoid additional regulatory oversight. As of December 31, 2015 and 2014, the Company had $6.5 million on deposit with various states in which it writes policies.
The Company is party to an arrangement with the father of the Company’s Chief Executive Officer, who serves as an independent contractor, to develop veterinary relationships and build referrals. The terms of the independent contractor agreement are consistent with the terms of other similar independent contractors that do business with the Company. Total amounts paid to the related party in 2015, 2014 and 2013 were $0.3 million.
At December 31, 2015, the Company had federal net operating loss carryforwards of $63.5 million. Use of the carryforwards is limited based on the future income of the Company. The federal net operating loss carryforwards will begin to expire in 2027. Approximately $3.1 million of the net operating loss (NOL) carryforwards relate to tax deductible stock-based compensation in excess of amounts recognized for financial statement purposes. To the extent that net operating loss carryforwards, if realized, relate to excess stock-based compensation, the resulting tax benefits will be recorded to stockholders’ equity, rather than to results of operations. Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of the Company’s net operating loss carryforwards and credit carryforwards may be limited if the Company experiences an ownership change. The Company has not performed a significant analysis to determine whether the qualifying change in ownership that would limit the utilization of the NOLs has taken place.
A valuation allowance is required to reduce the deferred tax assets reported if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. After consideration of all the evidence, both positive and negative, the Company has recorded a full valuation allowance against its deferred tax assets at December 31, 2015 and 2014, because the Company’s management has determined that it is more likely than not that these assets will not be fully realized.
The Company is open to examination by the U.S. federal tax jurisdiction for the years ended December 31, 2012 through 2015. The Company is also open to examination for 2007 and forward with respect to net operating loss carryforwards generated and carried forward from those years in the United States. The Company is open to examination by the Canada Revenue Agency for the years ended December 31, 2011 through 2015 for all corporate tax matters, and open for the years ended December 31, 2008 through 2015 for transactions with non-arm’s length non-Canadian residents.
The Company accounts for uncertain tax positions based on a two-step process of evaluating recognition and measurement criteria. The first step assesses whether the tax position is more likely than not to be sustained upon examination by the taxing authority, including resolution of any appeals or litigation, on the basis of the technical merits of the position. If the tax position meets the more-likely-than-not criteria, the portion of the tax benefit greater than 50% likely to be realized upon settlement with the relevant tax authority is recognized in the financial statements. Net unrecognized tax benefits, interest, and penalties not expected to be settled within one year are included in other long-term liabilities on the consolidated balance sheets. No significant changes in uncertain tax positions are expected in the next twelve months.