See note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a description of the method used to compute basic and diluted net loss per share attributable to common stockholders.
We are a direct-to-consumer monthly subscription service providing a medical 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 available 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 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. While these referrals accounted for a majority of our enrollments during 2014, we do not pay commissions to or otherwise compensate veterinarians for their referrals. 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 acquisition cost.
Our revenue increased from $83.8 million for the year ended December 31, 2013 to $115.9 million for the year ended December 31, 2014, representing 38% year-over-year growth. We have made and expect to continue to make substantial investments in member acquisition and in expanding our operations. For the year ended December 31, 2014, 2013, and 2012, we had a net loss of $21.2 million, $8.2 million, and $6.4 million, respectively. As of December 31, 2014, our accumulated deficit was $57.2 million.
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 expense (benefit). For more information about adjusted EBITDA and a reconciliation of net loss to adjusted EBITDA, see Non-GAAP Financial Measures below.
We believe that using adjusted revenue, contribution margin and acquisition cost to calculate and present certain of our other key metrics is helpful to our investors. These measures, which are non-GAAP financial measures, are not prepared in accordance with U.S. GAAP. We define adjusted revenue as revenue from our subscription business segment excluding sign-up fee revenue and the change in deferred revenue between periods. We define contribution margin as 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. We define acquisition cost as sales and marketing expenses, excluding stock-based compensation expense, net of sign-up fee revenue.
Because of varying available valuation methodologies, subjective assumptions and the variety of equity instruments that can impact a company’s non-cash expenses, we believe that providing non-GAAP financial measures such as contribution margin, acquisition cost and adjusted EBITDA that exclude stock-based compensation expense and, in the case of adjusted EBITDA, the change in fair value of warrant liabilities allows for more meaningful comparisons between our operating results from period to period. We exclude sign-up fee revenue from the calculation of both adjusted revenue and contribution margin because we collect it from new members at the time of enrollment and consider it to be an offset to a portion of our sales and marketing expenses. For this reason, we also net sign-up fees with sales and marketing expenses in our calculation of acquisition cost. We exclude changes in deferred revenue from the calculation of both adjusted revenue and contribution margin in order to eliminate fluctuations caused by the timing of pet enrollment during the last month of any particular period in which such measures are being presented or utilized. We exclude the change in fair value of warrant liabilities from our calculation of adjusted EBITDA in order to eliminate fluctuations caused by changes in our stock price. We believe this allows us to calculate and present adjusted revenue, contribution margin and 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.
Investment in pet acquisition. We have made and plan to continue to make significant investments to grow our member base. Our acquisition cost and the number of new members we enroll depends on a number of factors, including the amount we elect to invest in sales and marketing activities in any particular period in the aggregate and by channel, effectiveness of our sales execution and marketing initiatives, changes in costs of media, the mix of our sales and marketing expenditures and the competitive environment. Our average pet acquisition cost has in the past significantly varied and in the future may significantly vary from period to period based upon specific marketing initiatives and the actual or expected relationship to LVP. For example, veterinary trade show costs have traditionally increased our average pet acquisition costs in the first quarter of each year and the timing of our Territory Partner conference can also increase our average pet acquisition cost in a given period. We also may periodically test new member acquisition channels and marketing initiatives, such as television advertising, each of which impacts our average pet acquisition cost. We plan to expand the number of Territory Partners and their associates, which is likely to increase our average pet acquisition cost. We continually assess our sales and marketing activities by monitoring the ratio of LVP to PAC.
Geographic mix of sales. The relative mix of our business between the United States and Canada impacts the monthly adjusted revenue per pet we receive. Prices for our plan in Canada are generally higher than in the United States, which is consistent with the relative cost of veterinary care in each country. As our revenue has grown faster in the United States compared to Canada, this geographic shift in the mix of business has reduced the growth in our monthly adjusted revenue per pet. In addition, as our mix of revenue changes between the United States and Canada, our exposure to foreign exchange fluctuations will be impacted.
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 with 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 operate in two business segments: subscription business and other business. Our subscription business segment includes revenue and expenses related to monthly subscriptions for our medical plan. Our other business segment includes revenue and expenses related to our other operations, including the writing of policies for an unaffiliated general agent and policies written under a federal government program. We report our financial information in accordance with U.S. GAAP.
We generate revenue in our other business segment primarily from writing policies for an unaffiliated general agent that offers pet insurance and from writing policies under a federal government program. Revenue from our other business segment is recognized on a pro rata basis over the enrollment term for each policy.
Gross profit is total revenue less cost of revenue. We expect gross profit as a percentage of revenue in our subscription segment to remain relatively consistent in the long-term, although there has been and may be in the future some periodic variability due to a number of factors, including the rate of claims occurrences during such periods and in the timing and significance of our pricing adjustments. The timing of our implementation of various initiatives to improve the experience of our members also may affect gross profit in the short-term. Further, as the mix of subscription business and other business changes and as our other business segment changes, this may impact our total gross profit as a percentage of revenue.
Our operating expenses are classified into three categories: sales and marketing, technology and development, and general and administrative. For each category, the largest component is personnel costs, which include salaries, employee benefit costs, bonuses and stock-based compensation.
continue to devote significant resources to enhance our member experience and, thereafter, decrease as a percentage of revenue.
Comparison of the years ended December 31, 2014, 2013 and 2012
Year ended December 31, 2013 compared to year ended December 31, 2012. Total revenue increased by $28.3 million to $83.8 million for the year ended December 31, 2013, or 51%. Revenue for our subscription business segment increased by $21.5 million to $76.8 million for the year ended December 31, 2013, or 39%. This increase in subscription business revenue was primarily due to a 35% increase in total subscription pets enrolled as of December 31, 2013 compared to December 31, 2012 and a slight increase in monthly adjusted revenue per pet during this period due primarily to increases in our pricing. The impact of these price increases was partially offset by a higher percentage of newly enrolled pets in the United States as compared to Canada, which have a lower monthly adjusted revenue per pet, and an approximate $0.8 million impact of foreign exchange rates on our Canadian revenue. Revenue from our other business segment increased $6.8 million to $7.0 million for the year ended December 31, 2013. We began generating revenue in our other business segment in November 2012 by writing policies for an unaffiliated general agent.
Year ended December 31, 2014 compared to year ended December 31, 2013. Cost of revenue for our subscription business segment was $86.4 million, or 82% of revenue, for the year ended December 31, 2014, compared to $61.9 million, or 81% of revenue, for the year ended December 31, 2013. This $24.5 million increase in subscription cost of revenue primarily 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 changes 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. We expect that the claims expense ratio and the cost of revenue as a percent of revenue will continue to be elevated during 2015 as price increases are generally implemented on our members’ annual anniversary dates. 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.
Year ended December 31, 2013 compared to year ended December 31, 2014. Sales and marketing expenses increased $1.9 million to $9.1 million for the year ended December 31, 2013, or 27%. The increase in sales and marketing expenses was primarily due to a $1.4 million increase in salaries and related employee expenses resulting from an 8% increase in sales and marketing headcount from December 31, 2012 to December 31, 2013 and an increase of $0.5 million in expenditures related to new and expanded sales and marketing initiatives. The decrease as a percentage of revenue in part reflects the impact of recurring revenue from existing members.
Year ended December 31, 2014 compared to year ended December 31, 2013. Technology and development expenses increased $5.0 million to $9.9 million for the year ended December 31, 2014, or 103%. The increase was primarily due to a $4.2 million increase in compensation expense and related cost, resulting from increased headcount as we made investments in new technology and infrastructure, and a $0.5 million increase in system hosting to support our infrastructure growth. In addition, $0.2 million of the total increase was due to software licenses and fees as a result of our company growth. Total expenses, net of capitalization, in technology related to claims processing improvements were $4.7 million in 2014 and $1.4 million in 2013.
Year ended December 31, 2014 compared to year ended December 31, 2013. General and administrative expenses increased $5.7 million to $14.3 million for the year ended December 31, 2014, or 65%. The increase in general and administrative expenses was primarily due to the recognition of stock-based compensation expense that was contingent upon our IPO of $1.4 million. Salaries and related expenses increased $1.8 million due to increased headcount to support our growth, transition to being a public company and a severance agreement with a former employee. Additionally, regulatory expenses increased $0.5 million due to contingent regulatory matters and we incurred $0.8 million related to public company readiness activities.
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, see “-Non-GAAP Financial Measures.”
As of December 31, 2014, we had cash and cash equivalents of $53.1 million and short-term investments of $22.4 million. We believe that our existing cash and cash equivalents and short-term investments will be sufficient to fund our operations and statutory capital requirements for at least the next 12 months. From time to time, we may explore additional financing, which could include equity, equity-linked and debt financing. However, there can be no assurance that any additional financing will be available to us on acceptable terms, or at all.
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 $0.5 million for obligations we may have outstanding from Square 1 for other ancillary services.
The Square 1 credit facility requires us to maintain certain financial covenants, including having APIC maintain statutory capital and surplus at all times of not less than the greater of $0.5 million or 110% of the highest amount of statutory capital and surplus required in any state in which APIC is licensed, maintaining a minimum cash balance of $0.5 million in our accounts at Square 1 (including for such purposes, APIC’s cash and depository products at Square 1), achieving certain monthly revenue and remaining within certain maximum EBITDA loss levels. EBITDA is defined for such purposes as earnings, plus an amount equal to the sum of (i) tax, plus (ii) depreciation and amortization, plus (iii) interest and non-cash expenses, plus (iv) any non-cash stock compensation expense, less (a) any increase in capitalized expenditures from the prior period, plus (b) any increase in capitalized software from the prior period, plus (c) any increase in deferred acquisition costs from the prior period.
To comply with these regulations, 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 additional indebtedness or pursue equity or debt financings or otherwise modify our business operations.
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, 2014, 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. Furthermore, effective January 1, 2015, due to our newly formed segregated account in Bermuda as part of our restructured relationship with Omega General Insurance Company, we are also subject to certain Canadian and Bermudian laws, as applicable at any given time. Additionally, effective January 1, 2015, in order to meet regulatory requirements in both Canada and Bermuda, we are required to fund a Canadian Trust account with the greater of C$2.0 million or 115% of unearned Canadian premium plus 15% of outstanding Canadian claims, including all incurred by not reported claims as well as required capital of C$1.3 million.
Net cash used in operating activities for the year ended December 31, 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.
Net cash used in investing activities for each of the periods presented was primarily related to the net purchase of investments to increase our statutory capital. We expect to continue increasing our statutory capital as we expand our operations. In addition, we made investments in software to be used internally for our technology initiatives and purchased other fixed assets related to our operations.
Historically, we have funded our operations through the issuance of common and preferred stock and the incurrence of indebtedness. In July 2014, we completed our IPO, pursuant to which we sold 8,193,750 shares of common stock at an offering price of $10.00 per share
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, 2014 are set forth below.
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.
Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies and estimates include those related to:
Compensation expense related to stock-based transactions, including employee and non-employee stock option awards, is measured and recognized in the financial statements based on fair value. The fair value of each option award is estimated on the grant date using the Black-Scholes-Merton option-pricing model. The stock-based compensation expense, net of forfeitures, is recognized on a straight-line basis over the requisite service periods of the awards, which are generally four years. All of our stock-based awards have been for instruments tied to our common stock.
Fair value of our stock-Because our stock was not publicly traded prior to our IPO, we estimated the fair value of our stock, as discussed in “-Pre-IPO Stock valuations.” Upon the completion of our IPO, our common stock was valued by reference to the publicly traded price of our common stock.
Expected volatility-As we do not have a significant trading history for our common stock, the expected stock price volatility for our common stock was estimated by taking the average historic price volatility for identified peers based on daily price observations over a period equivalent to the expected term of the stock option grants and warrant issuances. We did not rely on implied volatilities of traded options or warrants in our industry peers’ common stock because the volume of activity was relatively low. We intend to continue to consistently apply this process using the same or similar public companies until a sufficient amount of historical information regarding the volatility of our own share price becomes available.
Expected term-The expected term represents the period that our stock-based awards are expected to be outstanding. As we do not have sufficient historical experience for determining the expected term of the stock-based awards granted, we have based our expected term for awards issued to employees on the simplified method, which represents the average period from vesting to the expiration of the stock option. The expected term for warrants is equal to the contract term.
Risk-free interest rate-The risk-free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the expected term of the options for each option group.
the rights, preferences, and privileges of our convertible preferred stock relative to those of our common stock;
In establishing estimates for these factors, we must make various assumptions regarding frequency and severity of claims, length of time to achieve ultimate settlement of claims, estimated deductible applicable to incurred claims, and changes in the cost of veterinary care. Due to the inherent uncertainty associated with these estimates, and the cost of incurred but unreported claims, our actual liabilities may be different from our original estimates. On a monthly basis, we review our reserve for claims and claims settlement costs to determine whether further adjustments are required. Any resulting adjustments are included in the current period’s results.
As of December 31, 2014 and 2013, our reserve for claims incurred but not yet reported was $5.1 million and $5.6 million, respectively. We believe the amount of our claims reserve as of December 31, 2014 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. In 2012, we experienced actual claims in excess of our estimate for our prior year reserves of less than $0.1 million. During 2014 and 2013, we experienced actual claims that were below our estimate for prior year reserves by $0.5 million and $0.1 million, respectively. Historically, approximately 95% of claims have been settled within three months of the claim date.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Trupanion, Inc. at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Trupanion, Inc. (collectively with its wholly-owned subsidiaries, the Company) is a direct-to-consumer monthly subscription service provider of a medical plan for cats and dogs throughout the United States, Canada and Puerto Rico.
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, warrant liabilities, 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 any cash account that is restricted as to withdrawal or use under the terms of certain financing agreements as restricted cash. Cash will be considered restricted for so long as any obligations are outstanding. Restricted cash pledged as collateral for the term loan totaled $3.0 million as of December 31, 2013. During 2014, this outstanding term loan was repaid in full, which also resulted in a release of the Company’s restricted cash.
Receivables are comprised of trade receivables and other miscellaneous receivables. As of December 31, 2014 and 2013, receivables included $6.8 million and $7.4 million, respectively, for one-year policies written by an unaffiliated general agent.
No single customer made up more than 5% of accounts receivable as of December 31, 2014 or 2013.
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, 2014, 2013 and 2012 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 when earned.
Costs related to software developed for internal use are primarily related to the Company’s website, internal support systems, and proprietary billing and claims systems. Costs are capitalized during the application development stage of the project and amortized on a straight-line basis over the estimated useful lives of the related assets, estimated between three and five years, once the software is placed into service.
Assets with finite lives are amortized over their estimated remaining useful life.
Sales and marketing expenses consist of referral fees paid with respect to newly enrolled pets, print, online and promotional advertising costs and employee compensation and related costs.
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. Omega retains an annual fee for fronting the Company’s insurance business in Canada, and all risks are retained within the Company. Premiums are recognized and earned pro rata over the terms of the related customer contracts. Premiums recognized from the agreement in 2014, 2013 and 2012 were $29.1 million, $24.7 million and $20.7 million, respectively and deferred revenue relating to this arrangement at December 31, 2014 and 2013 was $0.9 million and $0.7 million, respectively. Reinsurance revenue was 25%, 29% and 37% of total revenue in 2014, 2013 and 2012, respectively. Cash designated for the purpose of paying claims related to this reinsurance agreement was $1.7 million and $1.6 million at December 31, 2014 and 2013, respectively.
Advertising costs are expensed as incurred. Advertising costs amounted to $3.2 million, $0.7 million and $0.3 million, in 2014, 2013 and 2012, respectively.
Financial instruments which potentially subject the Company to concentration of credit risk consist primarily of cash and cash equivalents, investments and accounts receivable. The Company manages its risk by investing cash equivalents and investment securities in money market instruments and securities of the U.S. government, U.S. government agencies and high-credit-quality issuers of debt securities.
In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standard Update (ASU) amending revenue recognition guidance and requiring more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Insurance contracts are excluded from the scope of this new guidance. The guidance is effective for annual and interim reporting periods beginning after December 15, 2016, with early adoption prohibited, and must be applied retrospectively or modified retrospectively. We are currently evaluating the impact this ASU will have on our consolidated financial statements.
Depreciation and amortization expense for property and equipment was $1.6 million, $0.9 million and $0.3 million for 2014, 2013 and 2012, respectively.
The amortized cost, gross unrealized holding losses, and fair value of available-for-sale and short-term investments by major security type and class of security were as follows as of December 31, 2014 and 2013 (in thousands):
Maturities of securities classified as available-for-sale were as follows (in thousands):
The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible.
When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:
Level 2 inputs: Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Investment securities: Debt securities classified as available-for-sale are measured using quoted market prices when quoted market prices are available. If quoted market prices in active markets for identical assets are not available to determine fair value, then the Company uses quoted prices of similar instruments and other significant inputs derived from observable market data obtained from third-party data providers. Short-term investments are carried at amortized cost and the fair value is disclosed in Note 3. Fair value is determined in the same manner as available-for-sale securities and is considered a Level 2 measurement.
In May 2013, the Company and an equity method investee came to an agreement to exchange the Company’s investment for shares of the Company’s common stock held by the investee. In addition, the Company obtained an exclusivity agreement which was recorded as an intangible asset. Per the terms of the contract, any intellectual property developed as a part of this relationship is the property of the Company. A loss of $0.1 million was recognized on this transaction in 2013.
Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2014, are as follows (in thousands):
The Company has entered into agreements with independent contractors to provide services for a period of time. Future commitments related to these contracts are as follows (in thousands):
During 2013, the Company determined that it owes goods and services tax (GST) and harmonized sales tax (HST) in Canada for certain intercompany fees charged to its Canadian entities from 2007 through 2013. The Company began a voluntary self-disclosure with the Canada Revenue Agency for these unpaid taxes in 2014 under the Canada Revenue Agency Voluntary Disclosures Program, which was accepted in 2014. The Company has accrued $0.9 million of GST/HST tax for the 2007 through 2013 tax years, including interest, related to prior period GST/HST unpaid taxes.
The Company received an inquiry from the Washington State Office of the Insurance Commissioner (OIC) in December 2012 concerning whether a subsidiary of the Company was properly licensed, and whether certain of its employees were properly licensed, under Washington law. The Company responded to this letter in January of 2013 confirming that our subsidiaries are licensed and that our employees are not required to be licensed under Washington law. In October 2013, OIC sent further correspondence informing APIC that the results of a market conduct examination regarding its use of unlicensed non-appointed producers were being referred to OIC’s enforcement committee and that such committee would notify APIC in the event action is taken in regard to possible violations. The Company received additional correspondence from the OIC in July 2014 informing it that the OIC is scheduling a regulatory examination to further assess the Company’s compliance. A regulatory examination took place during the third and fourth quarters of 2014. As of December 31, 2014, the Company had accrued liabilities of $0.2 million 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 outcomes of the Company’s legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to our operating results and cash flows for a particular period. The Company makes a provision for a liability relating to legal matters when it is both probable that a liability beyond previously accrued amounts has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter.
The decrease in incurred claims for prior years in the year ended December 31, 2014 and December 31, 2013 is primarily due to less claims than expected for 2013 and 2012 claims, respectively. For the year ended December 31, 2012, the increase in incurred claims for prior years is primarily due to unanticipated claims development in those years from prior year claims and the corresponding change in the estimates of ultimate liabilities for incurred claims.
The Company has a revolving line of credit with Square 1 Bank, which is secured by any and all interest the Company has in assets that are not otherwise restricted. The revolving line of credit bore a variable interest rate as of December 31, 2014 and 2013, equal to the greater of 5.0% or 1.5% plus the prime rate. Interest expense is due monthly on the outstanding principal amount with all amounts outstanding under the revolving line of credit due upon maturity in July 2016. The credit agreement requires the Company to comply with various financial and non-financial covenants. As of December 31, 2014, the Company was in compliance with these covenants. This facility also has a compensating balance requirement of $0.5 million.
In June 2014, the Company’s Board of Directors adopted the 2014 Equity Incentive Plan (2014 Plan), which succeeded the 2007 Equity Compensation Plan upon the Company’s IPO. The 2014 Plan authorizes the award of stock options or restricted stock to directors, officers, employees, and non-employees. All awards have 10-year contractual terms. At December 31, 2014, there were 2,252,752 additional shares available for the Company to grant under the 2014 Plan.
Stock option activity for the years ended December 31, 2014, 2013 and 2012 was as follows:
As of December 31, 2014, stock options outstanding had a weighted average remaining contractual life of 6.8 years and vested and exercisable options had a weighted average remaining contractual life of 5.5 years.
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, 2014, 2013, and 2012:
Stock-based compensation expense includes stock options, restricted stock units and restricted stock awards granted to employees and non-employees, and is reported in the Company’s consolidated statement of operations in claims expenses, other cost of revenue, sales and marketing, technology and development, and general and administrative expenses depending on the function performed by the employee or non-employee. The Company measures stock-based compensation expense on a straight-line basis, except for the restricted stock with a performance condition which is measured on a graded vesting schedule. Stock-based compensation expense recognized in each category of the consolidated statement of operations for the years ended December 31, 2014, 2013 and 2012 was as follows (in thousands):
As of December 31, 2014, the Company had unrecognized stock-based compensation expense of $7.2 million, which is expected to vest over a weighted-average period of approximately 1.94 years. As of December 31, 2014, the Company had 1,534,418 unvested stock options and 592,625 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.
As of December 31, 2014, the Company had 200,000,000 shares of common stock authorized and 27,830,941 shares of common stock outstanding. Holders of common stock are entitled to one vote on each matter properly submitted to the stockholders of the Company except those related to matters concerning possible outstanding preferred stock. At December 31, 2014, the Company had 10,000,000 shares of undesignated shares of preferred stock authorized for future issuance and did not have any outstanding shares of preferred stock. The holders of common stock are also entitled to receive dividends as and when declared by the board of directors of the Company, whenever funds are legally available. These rights are subordinate to the dividend rights of holders of all classes of stock outstanding at the time. The Company is unable to pay dividends to stockholders as of December 31, 2014 due to restrictions in its credit agreements.
Immediately prior to the Company’s IPO, there were warrants to purchase 1,164,085 shares of common stock outstanding, of which warrants to purchase 415,646 of shares of common stock were issued on July 2, 2014 in connection with an amended and restated credit agreement that contained terms modifying the exercise price and number of underlying shares upon completion of an IPO, resulting in historical liability classification in the consolidated balance sheet. Upon the closing of the IPO, the number of shares underlying these warrants was adjusted to 869,999 shares, and the exercise price of each warrant was adjusted to $10.00 per share. These warrants were also revalued resulting in a gain of $2.0 million, which was recorded in other (income) expense, net in the statement of operations. Immediately following the IPO, these warrants were no longer subject to contractual modification provisions and were reclassified from a liability classification to an equity classification on the consolidated balance sheet.
Substantially all of the Company’s assets were located in the United States as of December 31, 2014 and 2013.
Under regulatory requirements at December 31, 2014, the amount of dividends that may be paid by the Company’s insurance subsidiary to the Company without prior approval by regulatory authorities was approximately $0.04 million. During 2014, 2013 and 2012, the Company’s insurance subsidiary did not pay any dividends to the Company.
In March 2012, the Company issued a mortgage loan to an employee in the amount of $0.8 million. In November 2013, the loan was repaid in full.
Income (loss) before income taxes was as follows for the years ended December 31, 2014, 2013 and 2012 (in thousands):
At December 31, 2014, the Company had federal net operating loss carryforwards of $44.4 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 $2.2 million of the net operating loss 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 (deficit), 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 is open to examination by the U.S. federal tax jurisdiction for the years ended December 31, 2011 through 2014. The Company is also open to examination for 2006 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, 2007 through 2014.
The following table contains selected unaudited financial data for each quarter of 2014 and 2013. The unaudited information should be read in conjunction with the Company’s financial statements and related notes included elsewhere in this report. The Company believes that the following unaudited information reflects all normal recurring adjustments necessary for a fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period.