Our principal executive offices are located at 6100 4th Avenue South, Seattle, Washington. The lease for our principal office is for 72,157 square feet and expires in July 2026. This lease includes provisions which increase our principal office space to a total of 90,385 square feet in 2017 and then to a total of 108,218 square feet in 2018. We also occupy 1,600 square feet of office space in Vancouver, British Columbia pursuant to a lease that expires in March 2017 which we plan to renew.
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, income tax expense (benefit) and loss (income) from equity method investment. For more information about Adjusted EBITDA, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Non-GAAP Financial Measures.”
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 partners 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 continuously 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.
Total subscription pets enrolled. Total subscription pets enrolled reflects the number of pets subscribed to the plan marketed by Trupanion to consumers at the end of each period presented. We monitor total subscription pets enrolled because it provides an indication of the growth of our subscription business.
Our non-GAAP financial measures may not provide information that is directly comparable to that provided by other companies in our industry as other companies in our industry may calculate or use non-GAAP financial measures differently. In addition, there are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with GAAP, may be different from non-GAAP financial measures used by other companies and exclude expenses that may have a material impact on our reported financial results. Further, stock-based compensation expense and other items used in the calculation of adjusted EBITDA have been and will continue to be for the foreseeable future significant recurring expenses in our business. The presentation and utilization of non-GAAP financial measures is not meant to be considered in isolation or as a substitute for the directly comparable financial measures prepared in accordance with GAAP. We urge our investors to review the reconciliation of our non-GAAP financial measures to the most directly comparable GAAP financial measures in our consolidated financial statements that is included below, and not to rely on any single financial or operating measure to evaluate our business.
We generate revenue in our other business segment primarily from writing policies on behalf of third parties where we do not undertake the direct consumer marketing. This segment includes the writing of policies that provide different coverage and may have materially different terms and conditions than our subscription medical plan.
Claims expenses include claims incurred, the cost of personnel administering the claims and providing member service relating to 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.
The following tables set forth our results of operations for the periods presented both in absolute dollars and as a percentage of our revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results.
Year ended December 31, 2015 compared to year ended December 31, 2014. Total revenue increased by $31.1 million to $147.0 million for the year ended December 31, 2015, or 27%. Revenue for our subscription business segment increased by $29.9 million to $133.4 million for the year ended December 31, 2015, or 29%. This increase in subscription business revenue was primarily due to a 27% increase in total subscription pets enrolled as of December 31, 2015 compared to December 31, 2014. Average revenue per pet increased from $44.14 to $45.04, or 2%, for the same period due to increases in pricing to cover the increased cost of veterinary care. The impact of the increase was partially offset by an approximate $4.8 million impact of foreign exchange rates on our Canadian revenue. Revenue from our other business segment increased $1.2 million to $13.6 million for the year ended December 31, 2015, or 9%, due to an increase in enrolled pets in this segment.
Year ended December 31, 2015 compared to year ended December 31, 2014. Cost of revenue for our subscription business segment was $109.4 million, or 82% of revenue, for the year ended December 31, 2015, compared to $85.2 million, or 82% of revenue, for the year ended December 31, 2014. This $24.3 million increase in subscription cost of revenue was primarily the result of a 27% increase in enrolled pets and a 29% increase in claims expense for our subscription business. Compensation expense and related costs increased by $1.8 million due to a 12% increase in employee headcount to service our growth and improve our member experience. There was an additional $3.5 million benefit of foreign exchange rates on our Canadian costs.
Cost of revenue for our other business segment increased $1.4 million to $12.3 million for the year ended December 31, 2015, due to an increase in enrolled pets in this segment. Our employer paid pets in this segment have historically been at a lower margin than other pets in this segment and they have increased 14% from 2014 to 2015, decreasing our other business segment gross margin from 12% to 9%.
Year ended December 31, 2015 compared to year ended December 31, 2014. Sales and marketing expenses increased $3.6 million to $15.2 million for the year ended December 31, 2015, or 31%. The increase in sales and marketing expenses was primarily due to an increase of $0.5 million in expenditures related to new and expanded online marketing initiatives and public relations, a $0.8 million increase in print advertising and brand development and a $1.1 million increase related to developing our territory partner network and support functions. Additionally, there was a $1.1 million increase in compensation and related costs and recruiting due to increased headcount in the sales and marketing department. Fees to our territory partners increased $0.3 million based on increased enrollments.
Year ended December 31, 2015 compared to year ended December 31, 2014. Technology and development expenses increased $1.3 million to $11.2 million for the year ended December 31, 2015, or 13%. The increase was primarily due to a $0.4 million increase related to infrastructure growth to support our growing business. Depreciation and amortization expense increased by $0.6 million as new projects relating to prior years were placed into service in 2015. Additionally, there was a $0.2 million increase in costs related to our direct pay initiative. Total expenses, net of capitalization, in technology related to our direct pay claims processing initiative were $4.3 million in 2015 and $4.4 million in 2014. Of these amounts, depreciation expense comprised $0.8 million in 2015 and $0.6 million in 2014.
Year ended December 31, 2016 compared to year ended December 31, 2015. General and administrative expenses decreased $0.4 million to $15.2 million for the year ended December 31, 2016, or 2%. This was primarily due to a decrease in personnel costs and related expenses of $0.6 million resulting from lower incentive compensation while headcount remained consistent. General and administrative expenses decreased from 11% to 8% as a percentage of revenue for the year ended December 31, 2016, as we experienced scale in our support functions.
Year ended December 31, 2016 compared to year ended December 31, 2015. Other expense, net for the year ended December 31, 2016 decreased $0.1 million to $0.2 million. This was primarily due to a $0.1 million decrease in interest expense resulting from a lower outstanding average loan balance compared to the prior year.
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 2014.
In April 2007, we entered into a loan and security agreement with Pacific Western Bank (PWB), formerly with Square 1 Bank, a division of PWB, which we amended and restated in August 2012 and June 2016. In December 2016, we replaced this agreement and entered into a syndicated loan agreement with PWB and Western Alliance Bank (WAB) that increased our facility from $20.0 million to $30.0 million. We refer to this amended and restated loan and security agreement as our PWB credit facility. The PWB credit facility provides for a revolving line of credit, under which we may take advances up to $30.0 million. The maximum amount available to us under the PWB credit facility, inclusive of any amounts outstanding under the revolving line of credit, is the lesser of $30.0 million and the total amount of cash and securities held by our insurance subsidiaries (APIC and WICL), less up to $0.5 million for obligations we may have outstanding from PWB and/or WAB for other ancillary services and our $1.1 million letter of credit.
Interest on the PWB credit facility accrues at a variable annual rate equal to the greater of 4.5% or 1.25% plus the prime rate. The PWB credit facility matures in December 2018 or December 2019 if the revolving line of credit is automatically renewed. The PWB credit facility automatically renews in January 2018 unless canceled by PWB and/or WAB.
The PWB 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 unrestricted cash balance of $0.6 million in our accounts at WAB and/or one or more WAB affiliates, maintaining all of our depository and operating accounts at PWB and/or WAB, achieving certain quarterly revenue and remaining within certain monthly 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, plus (v) loss from equity method investments, and minus gain from equity method investments.
Our obligations under the PWB credit facility are secured by substantially all of our assets and a pledge of certain of our subsidiaries’ stock. As of December 31, 2016, we had $5.0 million aggregate borrowings outstanding under the PWB credit facility.
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, 2016, APIC was required to maintain at least $25.8 million of risk-based capital to avoid this additional regulatory oversight. As of that date, APIC maintained $30.5 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, 2016, $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.
WICL Segregated Account AX was established by WICL, with Trupanion, Inc. as the shareholder, to enter into a reinsurance agreement with Omega General Insurance Company. All of the assets and liabilities of WICL Segregated Account AX are legally segregated from other assets and liabilities within WICL and all shares of the segregated account are owned by Trupanion, Inc. Our agreements with WICL do not allow dividends to be paid to our parent company until 2017. Subsequent to December 31, 2016, our parent entity received a dividend of $2.7 million from Wyndham Insurance Company (SAC) Limited (WICL) Segregated Account AX as allowed under our agreements with WICL. As required by the Office of the Superintendent of Financial Institutions regulations related to our reinsurance agreement with Omega General Insurance Company, we are required to maintain a Canadian Trust account with the greater of CAD $2 million or 115% of unearned Canadian premium plus 15% of outstanding Canadian claims, including all incurred but not reported claims.
We derive operating cash flows from cash collected from the sale of subscriptions to our medical plan, which is used to pay claims and other cost of revenue. Additionally, cash is used to support the growth of our business by reinvesting to acquire new pets and projects to improve member experience.
Net cash provided by operating activities for the year ended December 31, 2016 consisted of our net loss of $6.9 million reduced by non-cash expenses, including stock-based compensation of $2.9 million and depreciation and amortization of $3.8 million and a $5.0 million change in operating assets and liabilities. The change in cash provided by (used in) operating activities was primarily related to the $10.3 million improvement in net loss, driven by higher revenue and decreased operating expenses as a percentage of revenue as we experienced efficiencies in our claims and customer service departments and experienced scale in our technology and development and general and administrative departments. Additionally, we reduced spend as a percentage of revenue in our sales and marketing department.
Net cash used in operating activities for 2015 consisted of our net loss of $17.2 million reduced by non-cash expenses, including stock-based compensation of $3.0 million and the 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 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 average revenue per pet.
Compensation expense related to stock-based transactions, including employee and non-employee stock option awards, and restricted stock awards and units, 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. All of our stock-based awards have been for instruments tied to our common stock. The stock-based compensation expense, net of estimated forfeitures, is recognized on a straight-line basis over the requisite service periods of the awards, which are generally four years. Many factors are considered when estimating forfeitures, including types of awards, employee class and historical experience.
Key assumptions. Our Black-Scholes-Merton option-pricing model requires the input of highly subjective assumptions, including the fair value of the underlying stock, the expected volatility of the price of our stock, the expected term of the option, risk-free interest rates and the expected dividend yield of our stock. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future. These assumptions are estimated as follows:
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
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.
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 2016, 2015 or 2014.
As of December 31, 2016 and 2015, our reserve for claims incurred but not yet reported was $9.5 million and $6.3 million, respectively. We believe the amount of our claims reserve as of December 31, 2016 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 2016, we experienced actual claims that were greater than our estimate for prior year reserves by $0.7 million. During 2015 and 2014, we experienced actual claims that were below our estimate for prior year reserves by less than $0.1 million and $0.5 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, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, 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.
Certain prior year amounts have been reclassified within the Company’s consolidated financial statements from their original presentation to conform to the current period presentation.
Receivables are comprised of trade receivables and other miscellaneous receivables. As of December 31, 2016 and 2015, receivables included $8.0 million and $7.2 million, respectively, for one-year policies written by an unaffiliated general agent. Accounts and other receivable are carried at their estimated collectible amounts.
The Company incurs certain costs related to the successful acquisition of new and renewal customer contracts, which are capitalized. These costs include premium taxes, fees and enrollment-based bonuses, 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, 2016, 2015 and 2014 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, net when earned.
A decline in the fair value of any available-for-sale security below amortized cost that is deemed to be other than temporary results in an impairment to reduce the amortized cost to fair value or recovery value. To determine whether an impairment is other than temporary, the Company considers its intent to sell the security, intent and ability to hold the security, as well as all available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable forecasts, when developing estimates of cash flows expected to be collected. Realized capital gains and losses are determined on a specific identification basis and recorded as a part of other expense, net in the statement of operations.
Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets ranging from three to five years. Leasehold improvements are depreciated over the less of their expected useful life or the remaining term of the related lease. Fixed assets under capital lease are depreciated over the lesser of their expected useful life or the remaining term of the related lease.
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.
No single customer accounted for more than 5% of the Company’s revenue in 2016, 2015 or 2014.
Claims expenses include claims incurred, the cost of personnel administering the claims and providing member service relating to claims, and other operating expenses directly or indirectly related to claims administration.
Sales and marketing expenses consist of costs to educate veterinarians and policy holders about the Company’s policy, converting leads to enrolled pets, print, online and promotional advertising costs and employee compensation and related costs.
Technology and development expenses consist primarily of personnel costs and related expenses for the Company’s operations staff, which includes information technology development and infrastructure support, third-party services and depreciation of hardware and capitalized software and amortization of intangible assets.
General and administrative expenses consist primarily of personnel costs and related expenses for the Company’s finance, actuarial, human resources, legal and general management functions, as well as facilities and professional services.
Effective January 1, 2015, the Company formed a segregated account in Bermuda as part of Wyndham Insurance Company (SAC) Limited (WICL), and entered into a revised fronting and reinsurance arrangement with Omega General Insurance Company (Omega) to include its newly formed segregated account. The Company maintains all risk with the business written in Canada and consolidates the entity in its financial statements. Contractual requirements restrict dividends from this entity until after 2016, at which time dividends will be allowed subject to the Segregated Accounts Company Act of 2000, which allows for dividends only to the extent that the entity remains solvent and the value of its assets remain greater than the aggregate of its liabilities and its issued share capital and share premium accounts.
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 2016, 2015 and 2014 were $36.5 million, $30.9 million and $29.1 million, respectively and deferred revenue relating to this arrangement at December 31, 2016 and 2015 was $1.3 million and $0.9 million, respectively. Reinsurance revenue was 19%, 21% and 25% of total revenue in 2016, 2015 and 2014, respectively. Cash designated for the purpose of paying claims related to this reinsurance agreement was $2.1 million and $2.0 million at December 31, 2016 and 2015, respectively. In addition, as required by the Office of the Superintendent of Financial institutions regulations related to the Company’s reinsurance agreement with Omega, 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 but not reported claims. As of December 31, 2016, the Company was in compliance with all requirements.
Advertising costs are expensed as incurred, with the exception of television advertisements, which are expensed the first time each advertisement is aired. Advertising costs amounted to $4.0 million, $5.3 million and $3.2 million, in 2016, 2015 and 2014, respectively.
The Company’s consolidated financial statements are reported in U.S. dollars. Assets and liabilities of international subsidiaries with non-U.S. dollar functional currencies are translated to U.S. dollars at the exchange rates in effect on the balance sheet date. Revenue and expenses for each subsidiary are translated to U.S. dollars using a weighted-average rate for the relevant reporting period. Translation adjustments resulting from this process are included in accumulated other comprehensive loss, and totaled $0.4 million, $0.4 million and $0.1 million as of December 31, 2016, 2015 and 2014, respectively. Gains and losses that arise from exchange rate fluctuations for monetary asset and liability balances that are not denominated in an entity’s functional currency are included within other income.
In November 2016, the FASB issued an ASU which requires amounts determined to be restricted cash and restricted cash equivalents to be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. This ASU is effective for fiscal periods beginning after December 15, 2018 including interim periods within that reporting period, with early adoption permitted. The Company adopted this ASU as of December 31, 2016 and has retrospectively applied all provisions by providing comparative disclosures for each period presented.
In March 2016, the FASB issued an ASU amending the accounting for employee share-based payments, including income tax recognition and classification. The entity may make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. Additionally, tax withholding of shares will be allowed up to the employees' maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award. Finally, under the new guidance, companies will no longer record excess tax benefits and certain tax deficiencies in additional paid-in capital on the balance sheet. Instead, companies will record all excess tax benefits and deficiencies as income tax expense or benefit in the income statement. This ASU is effective for fiscal years beginning after December 15, 2016 including interim periods within that reporting period, with early adoption permitted. The Company adopted this guidance as of January 1, 2017. The Company has determined the guidance for estimating forfeitures does not currently have a material impact to the financial statements. The guidance for tax withholding on RSU's may have a material impact on cash flow from financing activities to the extent individual employees elect to withhold shares at rates higher than the statutory minimum. The guidance related to the accounting for excess tax benefits and deficiencies will result in an initial adjustment as of January 1, 2017 to the Company's net operating loss deferred tax asset to eliminate the Company's existing APIC pool amounting to $4.3 million, which will be offset by an adjustment to the company's valuation allowance.
In August 2016, the FASB issued an ASU which addresses eight specific cash flow issues intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This ASU is effective for fiscal periods beginning after December 15, 2017 including interim periods within that reporting period, with early adoption permitted. The Company plans to adopt this guidance as of January 1, 2018. The Company is in the process of assessing the impact of this guidance.
Property and equipment, along with their useful lives, were as follows for the years ended December 31, 2016 and 2015 (in thousands):
Depreciation expense for property and equipment was $3.8 million, $2.5 million and $1.6 million for 2016, 2015 and 2014, respectively.
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, 2016.
The Company had one investment with an unrealized loss of less than $0.1 million and a fair value of $1.0 million at December 31, 2016 and an unrealized loss of $0.1 million and a fair value of $0.9 million at December 31, 2015. This investment has been in an unrealized loss position for more than 12 months. The Company assessed the bond for credit impairment and determined that there is no intent to sell this bond and it is likely that it will hold the investment for a period of time sufficient to allow for recovery. Furthermore, future payments on this bond are insured by a financial guarantee insurer. Therefore, the Company believes that the unrealized loss on this bond constitutes a temporary impairment.
Level 1 inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.
During 2015, the Company invested $0.3 million in a software development company in exchange for 300,000 units of Series A preferred stock resulting in a 13% equity interest. This agreement was amended and restated on September 12, 2016 to increase Series A preferred stock from 300,000 units to 750,000 units resulting in a 20% equity interest. The Company’s equity interest 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 operating leases, related to equipment and office facilities, which expire over the next three years with various renewal options. Minimum rent payments under operating leases are recognized on a straight-line basis over the term of the lease. Rental expense for operating leases was $1.2 million, $1.0 million and $0.8 million during 2016, 2015 and 2014, respectively.
Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2016, are as follows (in thousands):
From time to time, the Company may be subject to various legal proceedings and claims in the ordinary course of business activities, including claims of alleged infringement of trademarks, copyrights and other intellectual property rights; employment claims; coverage disputes with policyholders; and general contract or other claims. The Company may, from time to time, also be subject to various other legal or government claims, disputes or investigations.
The outcomes of the Company’s legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to the Company’s 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 Company provides a reserve for claims incurred but not reported (IBNR). This liability is primarily based on, but not limited to, patterns of claims being paid, patterns of claims being received, seasonality patterns and historical experience. As the Company grows, the IBNR claim liability is expected to increase. Additionally, if expected claims paying completion patterns extend, the IBNR claim liability further increases. The Company reviews estimates for reported but unpaid claims and IBNR claims quarterly. Any necessary adjustments are reflected in earnings.
Activity in the subscription business claims reserve is summarized as follows (in thousands):
The decrease in other business claims for prior years in the years ended December 31, 2016, December 31, 2015 and December 31, 2014 is primarily due to less claims incurred than expected relating to prior year claims.
The following table summarizes the activity for incurred claims and claim adjustment expenses for the Company's other business segment (in thousands, except for cumulative number of claims data; includes non-cash expenses incurred during the period):
The following table summarizes the activity for cumulative claims paid and claim adjustment expenses (CAE) for the Company's subscription business segment (in thousands; includes non-cash expenses incurred during the period):
The Company has a revolving line of credit with a bank, which is secured by any and all interest the Company has in assets that are not otherwise restricted. On December 16, 2016, the Company replaced its previous line of credit agreement and entered into a syndicated loan agreement with Pacific Western Bank and Western Alliance Bank increasing its facility from $20.0 million to $30.0 million. The revolving line of credit bore a variable interest rate as of December 31, 2016 equal to the greater of 4.5% or 1.25% plus the prime rate, and as of December 31, 2015 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 December 2018, or December 2019 if the revolving line of credit is renewed. The revolving line of credit automatically renews January 2018 unless canceled by the bank. The credit agreement requires the Company to comply with various financial and non-financial covenants. As of December 31, 2016 and December 31, 2015, the Company was in compliance with all covenants. This facility had a requirement that $0.6 million be held as restricted cash with the bank as of December 31, 2016. This facility also had a compensating balance requirement of $0.5 million as of December 31, 2016 and December 31, 2015.
Borrowings on the revolving line of credit were limited to the lesser of $30.0 million in 2016 and $20.0 million in 2015, and the total amount of cash and securities held by the Company's insurance subsidiaries (APIC and WICL), less up to $3.0 million, for obligations the Company may have outstanding for other ancillary services in the future. As of December 31, 2016, the Company's outstanding borrowings under this facility were $5.0 million. During 2015, the Company repaid its borrowings under this facility, and as of December 31, 2015, the Company had no outstanding borrowings under this facility.
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, 2016, there were 3,901,594 additional shares available for the Company to grant under the 2014 Plan.
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, 2016, 2015, and 2014:
During the third quarters of 2016, 2015 and 2014, 116,877 shares of restricted stock, which were subject to a performance condition relating to the Company’s IPO, vested and resulted in $0.5 million, $0.9 million and $1.6 million of expense, respectively, included in general and administrative expense in the consolidated statement of operations. The fair value of these vested shares was approximately $1.8 million, $0.9 million and $1.2 million, respectively. The remaining 350,631 shares of unvested restricted stock related to this agreement are expected to vest over the remaining service term of approximately 3.0 years.
As of December 31, 2016, the Company had 100,000,000 shares of common stock authorized and 29,498,947 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, 2016, 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, 2016 due to restrictions in its credit agreements.
At December 31, 2016 and 2015, the Company had warrants to purchase 810,000 shares and 869,999 shares of common stock, respectively, at $10.00 per share, which begin to expire in 2018. At the end of each reporting period prior to the July 23, 2014, warrants were subject to contractual modification provisions and the Company adjusted the fair value of the warrants. For periods subsequent to July 23, 2014, 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.
The Company has two segments: subscription business and other business. The subscription business segment includes monthly subscriptions related to the Company’s medical plan which are marketed directly to consumers, while the other business segment includes all other business that is not directly marketed to consumers.
Substantially all of the Company’s long-lived assets were located in the United States as of December 31, 2016 and 2015.
Under regulatory requirements at December 31, 2016, the amount of dividends that may be paid by the Company’s insurance subsidiary in New York to the Company without prior approval by regulatory authorities was $0.1 million. During 2016, 2015 and 2014, the Company’s insurance subsidiaries did not pay any dividends to the Company. Subsequent to December 31, 2016, the Company received a dividend of $2.7 million from Wyndham Insurance Company (SAC) Limited (WICL) Segregated Account AX as allowed under the Company's agreements with WICL.
Loss before income taxes was as follows for the years ended December 31, 2016, 2015 and 2014 (in thousands):
A reconciliation of income tax expense at the statutory federal income tax rate and income taxes as reflected in the financial statements is presented below:
At December 31, 2016, the Company had federal net operating loss carryforwards of $79.0 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 $12.7 million of the net operating loss (NOL) carryforwards relate to tax deductible stock-based compensation in excess of amounts recognized for financial statement purposes. 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. As of December 31, 2016, the utilization of approximately $0.5 million of net operating losses are subject to limitation as a result of prior ownership changes; however, subsequent ownership changes may further affect the limitation in future years.
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, 2016 and 2015, 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, 2013 through 2016. 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, 2012 through 2016 for all corporate tax matters, and open for the years ended December 31, 2009 through 2016 for transactions with non-arm’s length non-Canadian residents.