This section of this Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2018.
The following tables set forth our key operating metrics for the periods ended December 31, 2019, 2018 and 2017, and for each of the last eight fiscal quarters.
Lifetime value of a pet, including fixed expenses. Lifetime value of a pet, including fixed expenses, is calculated 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. This amount is also reduced by the fixed expenses related to our subscription business, which are the pro-rata portion of general and administrative and technology expenses, less stock-based compensation and depreciation, based on revenues. This amount, on a per pet basis, is 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 lifetime value of a pet, including fixed expenses, to estimate the value we might expect from new pets over their implied average subscriber life in months, if they behave like the average pet in that respective period. When evaluating the amount of sales and marketing expenses we may want to incur to attract new pet enrollments, we refer to the lifetime value of a pet, including fixed expenses, as well as our estimated internal rate of return calculation for an average pet, which also includes an estimated surplus capital charge, to inform the amount of acquisition spend in relation to the estimated payback period.
Starting with the year ended December 31, 2019, we have modified our calculation of lifetime value of a pet (LVP) to include fixed expenses in order to make this a more fulsome metric when evaluating the payback period compared to pet acquisition cost. The following table reflects the reconciliation of our historical presentation of LVP to lifetime value of a pet, including fixed expenses, for our subscription business in the periods indicated:
Cost of revenue in each of our segments is comprised of the following:
Average monthly retention. Our performance depends on our ability to continue to retain our existing and newly enrolled pets and is impacted by our ability to provide a best-in-class value and member experience. Our ability to retain enrolled pets depends on a number of factors, including the actual and perceived value of our services and the quality of our member experience, the ease and transparency of the process for reviewing and paying veterinary invoices for our members, and the competitive environment. In addition, other initiatives across our business may temporarily impact retention and make it difficult for us to improve or maintain this metric. For example, if the number of new pets enrolled increases at a faster rate than our historical experience, our average monthly retention rate could be adversely impacted, as our retention rate is generally lower during the first year of member enrollment.
Other business segment. Our other business segment primarily includes revenue and expenses related to policies written on behalf of third parties. This segment includes products that have been in the past, and may be in the future, materially different from our subscription. Our relationships in our other business segment are generally subject to termination provisions and are non-exclusive. Accordingly, we cannot control the volume of business, even if a contract is not terminated. Loss of an entire program via contract termination could result in the associated policies and revenues being lost over a period of 12 to 18 months, which could have a material impact on our results of operations. We may enter into additional relationships in the future to the extent we believe they will be profitable to us, which could also impact our operating results.
The following tables set forth our results of operations for the periods presented both in absolute dollars and as a percentage of total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results.
Comparison of the years ended December 31, 2019, 2018, and 2017
Year ended December 31, 2019 compared to year ended December 31, 2018. Total revenue increased by $80.0 million to $383.9 million for the year ended December 31, 2019, or 26%. Revenue from our subscription business segment increased by $57.4 million to $321.2 million for the year ended December 31, 2019, or 22%. This increase was primarily due to a 15% increase in total subscription pets enrolled as of December 31, 2019 compared to December 31, 2018 and increased average revenue per pet of 6% for the same period. Increases in pricing were due to the increased cost and utilization of veterinary care. Revenue from our other business segment increased by $22.6 million to $62.8 million for the year ended December 31, 2019, or 56%, primarily due to the increase in enrolled pets in this segment.
Year ended December 31, 2019 compared to year ended December 31, 2018. Technology and development expenses increased by $0.8 million, or 9%, to $10.1 million for the year ended December 31, 2019. The change was primarily due to a $1.0 million increase in compensation and third party contractor expenses, net of capitalization, partially offset by a $0.4 million decrease in depreciation and amortization expenses. Technology and development expenses remained consistent at 3% as a percentage of revenue year over year.
Year ended December 31, 2019 compared to year ended December 31, 2018. Total other (income) expense, net increased by $0.2 million, primarily due to higher interest income from increased investment balance, partially offset by higher interest expense on debt.
The following tables contain selected quarterly financial information for the years ended December 31, 2019 and 2018. The unaudited quarterly information has been prepared on a basis consistent with the audited consolidated financial statements and includes all adjustments that we consider necessary for a fair presentation of the information shown. These quarterly operating results for any fiscal quarter are not necessarily indicative of the operating results for any full fiscal year or future period.
As of December 31, 2019, we had $98.9 million of cash, cash equivalents, and short-term investments and $23.3 million available under our line of credit, which excluded $0.5 million reserved for ancillary services. Most of the assets in our insurance subsidiary, American Pet Insurance Company (APIC), and our segregated cell business, Wyndham Insurance Company (SAC) Limited (WICL) 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, 2019, total assets and liabilities held outside of our insurance entities were $94.2 million and $42.0 million, respectively, including $5.3 million of cash and cash equivalents that were segregated from other operating funds and held in trust for the payment of veterinary invoices on behalf of our insurance subsidiaries.
We believe our cash and cash equivalents, short-term investments and line of credit are sufficient to fund our operations and capital requirements for the next 12 months. As we continue to grow, however, we may explore additional financing to fund our operations or to meet capital requirements. Financing could include equity, equity-linked, or debt financing. Additional financing may not be available to us on acceptable terms, or at all.
In November 2019, our board of directors approved a share repurchase program, pursuant to which we may repurchase up to $15.0 million of our outstanding shares over the next 12 months. Each quarter throughout this period, we intend to establish repurchase parameters reflecting our business’s capital allocation priorities, the market price of our common stock and general market conditions. We cannot predict when or if we will repurchase any shares of common stock, as such repurchases will depend on a number of factors, some of which are beyond our control. We did not repurchase any shares under this program for the year ended December 31, 2019.
Cash provided by financing activities was $14.0 million and $71.2 million for the years ended December 31, 2019 and 2018, respectively. The decrease of $57.2 million was primarily due to net proceeds of $65.7 million received from the June 2018 follow-on public offering, partially offset by a $10.0 million repayment of the line of credit in the prior year.
We have a syndicated loan agreement with Pacific Western Bank (PWB) and Western Alliance Bank (WAB), providing us a revolving line of credit of up to $50.0 million with a maturity date in June 2022. We refer to this line of credit as our PWB credit facility. 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 $50.0 million or the total amount of cash and securities held by our insurance entities, less amounts outstanding relating to other ancillary services and letters of credit, totaling $0.5 million as of December 31, 2019. Interest on the PWB credit facility accrues at a variable annual rate equal to the greater of 4.5% or 0.75% plus the prime rate (5.50% at December 31, 2019).
The PWB credit facility requires us to maintain certain financial and non-financial covenants, including maintaining a minimum cash balance of $1.4 million in our account at WAB and/or WAB affiliates and other cash or investments of $2.1 million in our accounts at PWB. As of December 31, 2019, we were in compliance with each of the financial and non-financial covenants.
As of December 31, 2019, our reserve for veterinary invoices was $21.2 million, consisting of $19.2 million for the amount we expect to pay in the future for veterinary invoices dated between January 1, 2019 and December 31, 2019, inclusive of related processing costs, and a reserve of $2.0 million for invoices dated prior to January 1, 2019. We believe the reserve amount as of December 31, 2019 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 balance 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.
For the year ended December 31, 2019, we paid $14.3 million for veterinary invoices dated on or before December 31, 2018, including related processing costs. Our reserve estimate for these expenses was $16.1 million as of December 31, 2018. As of December 31, 2019, we reevaluated the remaining reserve for those periods prior to December 31, 2018 and recorded an adjustment to our income statement to increase it by $0.2 million.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 13, 2020 expressed an unqualified opinion thereon.
The Company’s reserve for veterinary invoices totaled $21.2 million as of December 31, 2019. As discussed in Note 1 to the financial statements, the Company’s reserve for veterinary invoices is based on an actuarial analysis of the Company’s historical experience including the number of veterinary invoices it expects to receive, the average cost of those veterinary invoices, the length of time between the date of the veterinary invoice and the date the Company receives the veterinary invoice, the members’ chosen deductibles and the Company’s expected cost to process and administer payments.
Auditing the Company’s reserve for veterinary invoices is complex due to the sensitivity of the estimated reserve to management assumptions including frequency and severity of loss and development factors applied to paid and reported invoices.
To evaluate the reserve for veterinary invoices, our audit procedures included, among others, testing the completeness and accuracy of the underlying invoice data and related contracts. We involved our actuarial specialists to assist in our evaluation of management’s methodologies and assumptions used in the calculation of the reserve and compared the Company’s recorded reserve to a range of reasonable estimates developed independently by our actuarial specialists.
Trupanion, Inc. (collectively with its wholly-owned subsidiaries, the "Company") provides medical insurance for cats and dogs throughout the United States, Canada and Puerto Rico. The Company believes its data-driven, vertically-integrated approach makes its subscription the highest value for pet owners, with pricing specific to each pet’s unique characteristics.
The Company considers any cash account that is contractually restricted to withdrawal or use to be restricted cash. The Company is party to a financing agreement requiring a restricted cash balance. As of December 31, 2019, the Company was in compliance with all requirements.
The Company is required to disclose information on all assets and liabilities reported at fair value that enables an assessment of the inputs used in determining the reported fair values. The fair value hierarchy prioritizes valuation inputs based on the observable nature of those inputs. The fair value hierarchy applies only to the valuation inputs used in determining the reported fair value of the investments and is not a measure of the investment credit quality. The hierarchy defines three levels of valuation inputs:
Long-lived assets, including property, equipment, and intangible assets, are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Should an impairment exist, the impairment loss would be measured as the amount the asset's carrying value exceeds its fair value. The Company has recognized no impairment loss on long-lived assets for the years ended December 31, 2019, 2018, and 2017.
Expected term for awards granted to employees -The Company has based its expected term for awards issued to employees on the simplified method, as permitted by the SEC Staff Accounting Bulletin Topic 14, Share-Based Payment;
Expected dividend yield-The Company has never declared or paid any cash dividends and does not presently plan to pay cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero.
In June 2016, the Financial Accounting Standards Board (FASB) issued an ASU amending the measurement of credit losses on financial instruments. The ASU requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. This replaces the existing incurred loss impairment model with an expected loss methodology, which will result in more timely recognition of credit losses. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within that reporting period, with early adoption permitted. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.
In August 2018, the FASB issued an ASU that eliminates certain disclosure requirements for fair value measurements, requires new disclosures regarding significant unobservable inputs used to develop Level 3 fair value measurements, and modifies certain existing disclosure requirements for Level 3 fair value measurements. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within that reporting period, with early adoption permitted. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.
The fair value of tangible assets of the acquired property considers the value of the property as if it were vacant. The fair value of acquired “above- and below-” market leases was based on the estimated cash flow projections utilizing discount rates that reflected the risks associated with the leases acquired. The amount recorded was based on the present value of the difference between (i) the contractual amounts to be paid pursuant to each in-place lease and (ii) management’s estimate of fair market lease rates for each in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the extended term for any leases with below-market renewal options. Other intangible assets acquired included amounts for in-place lease values that were based on the Company’s evaluation of the specific characteristics of each tenant’s lease. Factors considered include estimates of carrying costs during hypothetical expected lease-up periods, market conditions and costs to execute similar leases. In estimating carrying costs, the Company included estimates of lost rents at market rates during the hypothetical expected lease-up periods, which were dependent on local market conditions. In estimating costs to execute similar leases, the Company considered leasing commissions, legal and other related costs.
The results of operations related to our ownership of the building are included in the Company’s consolidated statements of operations from the date of acquisition.
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.
Maturities of debt securities classified as available-for-sale were as follows (in thousands):
The Company measures the fair value of restricted cash, money market funds, and foreign deposits based on quoted prices in active markets for identical assets. The fair value of the municipal bond is based on either recent trades in inactive markets or quoted market prices of similar instruments and other significant inputs derived from or corroborated by observable market data. Short-term investments are carried at amortized cost and the fair value is disclosed in Note 5, Investments. The fair value of these investments is determined in the same manner as for available-for-sale securities and is considered a Level 1 measurement.
The Company's other long-term assets balance included notes receivable of $6.1 million and $3.0 million as of December 31, 2019 and 2018, respectively, recorded at their estimated collectible amount. The Company estimates that the carrying value of the notes receivable approximates the fair value. The estimated fair value represents a Level 3 measurement within the fair value hierarchy, and is based on market interest rates and the assessed creditworthiness of the third party.
The Company estimates the fair value of long-term debt based upon rates currently available to the Company for debt with similar terms and remaining maturities. This is a Level 3 measurement. Based upon the terms of the debt, the carrying amount of long-term debt approximated fair value at December 31, 2019 and December 31, 2018.
The Company's reserve for the subscription business segment increased $1.6 million from $13.9 million at December 31, 2018 to $15.5 million at December 31, 2019. This change was comprised of $232.4 million in expense recorded during the period less $230.0 million in payments of veterinary invoices. This $232.4 million in veterinary invoice expense incurred included an increase of $0.6 million to the reserves relating to prior years, which was the result of ongoing analysis of recent payment trends. The Company's adjustments to prior year reserves were an increase of $0.4 million and a reduction of $0.1 million as a result of analysis of payment trends in the years ended December 31, 2018 and 2017, respectively.
The Company’s reserve for the other business segment increased $3.5 million from $2.2 million at December 31, 2018 to $5.7 million at December 31, 2019. This change was comprised of $38.5 million in expense recorded during the period less $35.1 million in payments of veterinary invoices. This $38.5 million in veterinary invoice expense incurred included a reduction of $0.4 million to the reserves relating to prior years, which was the result of ongoing analysis of recent payment trends. The Company's adjustments to decrease prior year reserves were $0.3 million and $0.2 million as a result of analysis of payment trends in each of the years ended December 31, 2018 and 2017, respectively.
In the following tables, the cumulative number of veterinary invoices represents the total number received as of December 31, 2019, by year the veterinary invoice relates to, referred to as the year of occurrence. If a pet is injured or becomes ill, multiple trips to the veterinarian may result in several invoices. Each of these veterinary invoices is included in the cumulative number, regardless of whether the veterinary invoice was paid. Information for years 2016 through 2018 is provided as required supplementary information. Amounts in these tables are presented on a constant currency basis to remove the impact of changes in the foreign currency exchange rate on development. The cumulative expenses as of the end of each year are revalued using the currency exchange rate as of December 31, 2019.
The following table summarizes the development of veterinary invoice expense, on a constant currency basis, for the Company's other business segment by year of occurrence (in thousands, except for cumulative number of veterinary invoices data):
In the following tables, amounts are by year the veterinary invoice relates to, referred to as the year of occurrence. Amounts in these tables are presented on a constant currency basis to remove the impact of changes in the foreign currency exchange rate. The cumulative amounts paid as of the end of each year are revalued using the currency exchange rate as of December 31, 2019. Information for years 2016 through 2018 is provided as required supplementary information.
The following table summarizes the amounts paid for veterinary invoices, inclusive of related internal processing costs and reported on a constant currency basis, for the subscription segment (in thousands):
The Company has a revolving line of credit of up to $50.0 million, maturing in June 2022. The facility is secured by any and all interests in the Company's assets that are not otherwise restricted. Interest on the revolving line of credit is payable monthly at the greater of 4.5% or 0.75% plus the prime rate (5.50% at December 31, 2019). The credit agreement includes other ancillary services and letters of credit of up to $4.5 million. It also requires a deposit of restricted cash of $1.4 million and a minimum cash or investment balance of $2.1 million. The credit agreement requires the Company to comply with various financial and non-financial covenants. As of December 31, 2019, the Company was in compliance with all financial and non-financial covenants required by the credit agreement.
As of December 31, 2019, the Company had 206,387 unvested stock options and 581,943 unvested restricted stock awards and restricted stock units. Total stock-based compensation expense of $1.4 million related to unvested stock options and $14.6 million related to unvested restricted stock awards and restricted stock units is expected to be recognized over a weighted-average period of approximately 1.1 years and 3.0 years, respectively.
As of December 31, 2019, stock options outstanding and stock options exercisable had a weighted average remaining contractual life of 5.1 years and 4.8 years, respectively.
The weighted-average grant date fair value per share and the fair value of options vested were as follows for the years ended December 31, 2019, 2018, and 2017:
The below table summarizes the Company’s restricted stock award and restricted stock unit activity for the years ended December 31, 2019, 2018 and 2017:
As of December 31, 2019, the Company had 100,000,000 shares of common stock authorized and 34,947,017 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, 2019, 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, 2019 due to restrictions in its credit agreements.
In June 2018, the Company completed a follow-on public offering (the June 2018 follow-on public offering) whereby the Company sold 2,090,909 shares of common stock at a price to the public of $33.00 per share. The Company received aggregate net proceeds from the June 2018 follow-on public offering of $65.7 million, after deducting underwriting discounts and commissions and offering expenses payable by the Company. The proceeds were primarily used to purchase real estate consisting of properties in use as the Company's home office. In addition, in August 2018, the Company issued 303,030 shares of common stock via a private placement to an accredited investor as a portion of the purchase price of the real estate. See Note 3, Property and Equipment.
During the year ended December 31, 2019, 480,000 of the Company's outstanding warrants were exercised. As of December 31, 2019, no warrants remained outstanding.
In November 2019, the Company's board of directors authorized a share repurchase program, pursuant to which the Company may repurchase up to $15.0 million of its outstanding shares over the next 12 months. The Company did not repurchase shares during the year ended December 31, 2019.
The chief operating decision maker reviews revenue, gross profit, and operating income (loss) to evaluate segment performance. Revenue, veterinary invoice expense, other cost of revenue, and sales and marketing expenses are generally directly attributed to each segment. Other operating expenses, such as technology and development expense and general and administrative expense, are allocated proportionately based on revenue in each segment. Interest and other expenses and income taxes are not allocated to the segments, nor included in the measure of segment profit or loss. The Company does not analyze discrete segment balance sheet information related to long-term assets.
Operating income (loss) of the Company’s segments were as follows (in thousands):
The Company's insurance subsidiary in Bermuda is regulated by the Bermuda Monetary Authority. Under the Bermuda Companies Act of 1981, as amended, a Bermuda company may not declare or pay a dividend or make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would be after the payment, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than its liabilities. The Segregated Accounts Company Act of 2000 further requires that dividends out of a segregated account can only be paid to the extent that the cell remains solvent. The value of its assets must remain greater than the aggregate of its liabilities, issued share capital, and share premium accounts. Per our contractual agreements with Wyndham Insurance Company (SAC) Limited, the allowable dividend is equivalent to the positive undistributed profit attributable to the shares. This insurance subsidiary paid the Company a dividend of $3.9 million, $2.2 million, and $2.7 million during the years ended December 31, 2019, 2018 and 2017, respectfully.
As of December 31, 2019, the Company’s insurance subsidiary in New York maintained $73.8 million of statutory capital and surplus which was above the required amount of $55.3 million of statutory capital and surplus to avoid additional regulatory oversight.
Loss before income taxes was as follows for the years ended December 31, 2019, 2018 and 2017 (in thousands):
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was signed into law making significant changes to the Internal Revenue Code, including, but not limited to, a corporate tax rate decrease to 21% effective January 1, 2018. In accordance with Staff Accounting Bulletin No. 118 ("SAB 118"), the Company recorded a $0.6 million income tax benefit in the year ended December 31, 2017 in relation to the remeasurement of its deferred tax liabilities.
At December 31, 2019, the Company had U.S. federal and state net operating loss carryforwards of $30.6 million (tax-effected) and U.S. federal income tax credits of $0.5 million. Use of carryforwards is limited based on the future income of the Company. The federal net operating loss carryforwards will begin to expire in 2027. 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, 2019, 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.
For the year ended December 31, 2019, the Company considers its foreign earnings to be indefinitely reinvested. These earnings relate to ongoing operations and have been reinvested in active business operations. While, following the enactment of the Tax Act, distributions from majority owned foreign affiliates are, generally, not subject to U.S. income tax, such distributions may be subject to non-U.S. withholding taxes. A deferred tax liability related to such withholding taxes, and U.S. taxes related to non-majority owned foreign investments have not been recorded.