TRUPANION, INC. quarterly report, Q2 FY2016

Trupanion, Inc. — 2016 Q2 Form 10-Q Summary

Business Context and Reporting Period

Trupanion provides medical insurance plans for cats and dogs in the United States, Canada and Puerto Rico. The filing covers the three and six months ended June 30, 2016; results are unaudited and presented under U.S. GAAP. The business consists primarily of a consumer subscription segment and a smaller other-business segment involving policies not directly marketed to consumers.

Financial Performance and Key Metrics

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Revenue	$45.8 million	$35.6 million	$88.5 million	$68.9 million
Gross profit	$8.3 million	$5.8 million	$15.6 million	$11.4 million
Gross margin	18%	16%	18%	16%
Operating loss	$(1.0) million	$(4.6) million	$(3.5) million	$(9.2) million
Net loss	$(1.0) million	$(4.6) million	$(3.5) million	$(9.6) million
Adjusted EBITDA	$0.5 million	$(3.2) million	$(0.5) million	$(6.5) million

Subscription revenue increased 31% year over year to $42.2 million in Q2 and $81.3 million for the first six months. Other-business revenue increased 9% to $3.7 million in Q2 and $7.2 million for the six-month period.
At June 30, 2016, total enrolled pets were 320,896, including 299,856 subscription pets, increases of 23% and 24%, respectively, from the prior-year period.
Monthly average revenue per pet increased 5% to $47.39 in Q2 and $46.77 for the six-month period. Average monthly retention was 98.64%, compared with 98.67% in the prior-year period.
Claims expenses increased with enrollment growth but declined as a percentage of subscription revenue to 71% in Q2 from 73% in the prior-year quarter. Subscription gross margin improved to 19% in Q2 and 18% for the six-month period.
Sales and marketing expense was $3.6 million in Q2 and $7.4 million for the first six months, representing 8% of revenue in each period. Average pet acquisition cost declined to $118 in Q2 and $120 for the six-month period, while lifetime value per pet increased to $622.
Cash provided by operating activities was $0.3 million for the six months ended June 30, 2016, compared with $8.9 million of cash used in the prior-year period. Investing cash flow was $(3.0) million, and financing cash flow was $2.7 million.
Cash and cash equivalents were $18.2 million, short-term investments were $27.2 million, and long-term investments were $2.5 million at June 30, 2016. The company reported $45.4 million of cash, cash equivalents and short-term investments for liquidity purposes.
Long-term debt was $1.0 million, with $17.4 million available under the revolving credit facility. The facility matures in July 2017, bears a variable interest rate subject to a 4.5% floor, and was subject to all covenant requirements at quarter-end.
The claims reserve was $7.6 million and deferred revenue was $12.4 million at June 30, 2016. The accumulated deficit was $77.9 million.

Material Changes Versus the Prior Comparable Period

Revenue growth was driven by a 24% increase in subscription pets and a 5% increase in average revenue per pet, including pricing increases intended to offset higher veterinary costs.
Gross margin expanded by approximately two percentage points, while total operating expenses declined from 29% to 20% of revenue in Q2 and from 29% to 22% for the first six months.
Technology and development expense declined 25% in Q2 and 22% for the six-month period, primarily due to lower compensation and third-party costs associated with the direct-pay initiative.
General and administrative expense declined 13% in Q2 and 6% for the six-month period, reflecting lower professional, regulatory and variable compensation costs.
The company moved from significant negative adjusted EBITDA to positive adjusted EBITDA in Q2, although adjusted EBITDA remained negative for the first six months.
Cash flow improved substantially, with operating activities becoming modestly cash-generative and the company borrowing $1.0 million under its revolving facility while receiving $1.8 million from stock-option exercises.

Guidance, Outlook, Commentary, Risks and Unusual Items

No quantified revenue, earnings or cash-flow guidance is provided in the filing. Management expects to continue investing in member acquisition, retention, technology and member experience.
Management expects sales and marketing expense to increase in absolute dollars as new channels and Territory Partners are added, although the company targets a long-term lifetime-value-to-acquisition-cost ratio of approximately 5-to-1.
Management expects technology and development and general and administrative expenses to decline as percentages of revenue as the business scales. Future claims costs and gross margins remain sensitive to veterinary-cost inflation, claim frequency and severity, pricing approvals and the timing of plan changes.
Management stated that existing cash, investments and credit availability should fund operations and statutory capital requirements for at least the next 12 months. However, insurance subsidiaries must maintain regulatory capital, limiting the availability of some cash and investments for general corporate purposes.
American Pet Insurance Company had a required risk-based capital level of $24.5 million at December 31, 2015 and maintained $26.1 million. Continued enrollment growth may require additional statutory capital.
The Washington State Office of the Insurance Commissioner matter was settled in July 2016 for less than the amount accrued as of March 31, 2016. The company stated that it otherwise believes the matter is closed, subject to continued compliance with recommendations.
Key risks include continued net losses, claims-reserve inadequacy, higher veterinary costs, member-retention deterioration, acquisition-cost increases, regulatory and licensing requirements, dependence on veterinary referral channels, competition, foreign-exchange exposure in Canada, technology and data-security failures, and possible need for additional capital.

Important Facts for Investors to Verify

Whether enrollment growth and the 98.64% retention rate continue without materially increasing claims costs or acquisition costs.
Whether positive quarterly adjusted EBITDA converts into sustained GAAP profitability and positive operating cash flow.
The adequacy of the $7.6 million claims reserve and the effect of veterinary-cost inflation and claim severity on future margins.
The amount of cash and investments legally available to the parent company after statutory capital, trust and other insurance restrictions.
Compliance with the revolving-credit covenants and the company’s ability to refinance or repay the facility at its July 2017 maturity.
The final financial impact of the OIC settlement and any continuing regulatory obligations.
Whether Canadian foreign-exchange movements, regulatory pricing approvals and the termination risk of third-party policy relationships affect future revenue.