TRUPANION, INC. quarterly report, Q2 FY2020

Business Context and Reporting Period

Trupanion, Inc. provides medical insurance for cats and dogs in the United States, Canada and Puerto Rico through subscription and other business segments. This unaudited Form 10-Q covers the three and six months ended June 30, 2020, compared with the same periods in 2019.

Key Financial Metrics

Metric	Q2 2020	Q2 2019	Six Months 2020	Six Months 2019
Revenue	$117.9 million	$92.2 million	$229.2 million	$179.2 million
Gross profit	$19.9 million	$14.7 million	$37.7 million	$29.7 million
Gross margin	16.8%	16.0%	16.5%	16.6%
Operating income (loss)	$1.5 million	$(2.1) million	$0.5 million	$(3.4) million
Net income (loss)	$1.4 million	$(1.9) million	$0.2 million	$(3.2) million
Operating cash flow	Not separately provided	Not separately provided	$7.8 million	$6.9 million

Q2 operating margin was approximately 1.3%, versus negative 2.3% in the prior-year quarter. Six-month operating margin was approximately 0.2%, versus negative 1.9%. Q2 diluted earnings per share were $0.04, compared with $(0.06); six-month diluted earnings per share were $0.01, compared with $(0.09).

Subscription revenue increased 19% in Q2 and 20% for the six-month period. Other business revenue increased 76% and 74%, respectively.
Subscription gross margin improved to 19% in Q2 from 17% and to 19% for the six-month period from 18%. Other business gross margin declined to 8% from 9% for both comparable periods.
Operating expenses increased 11% for the six months, but declined to 16% of revenue from 18%; sales and marketing increased 16% while representing 9% of revenue, unchanged from the prior period.
Total pets enrolled reached 744,727 at June 30, 2020, up 29% year over year; subscription pets reached 529,400, up 15%.
Monthly average revenue per subscription pet was $59.40 in Q2 and $59.19 for the six-month period, up 4% and 5%, respectively.
Average monthly retention was 98.66%, compared with 98.57%. Average pet acquisition cost was $199 in Q2 versus $213 and $222 for the six months versus $209.

Cash, Liquidity and Debt

Cash and cash equivalents were $30.0 million at June 30, 2020, compared with $29.2 million at December 31, 2019. Short-term investments were $75.2 million, and total cash, cash equivalents and short-term investments were $105.2 million.
Cash, cash equivalents and restricted cash increased by $0.8 million during the first six months. Operating cash flow was $7.8 million, investing cash flow was $(8.9) million and financing cash flow was $2.4 million.
Long-term debt was $27.3 million. The revolving credit facility provides capacity of up to $50.0 million, matures in June 2022 and had $22.2 million of available borrowing capacity at June 30, 2020. Borrowings under the facility were $27.5 million before financing fees, and $0.3 million was outstanding for ancillary services and letters of credit.
The company was in compliance with all credit-facility covenants. The facility requires restricted cash of $1.4 million and minimum cash or investment balances.
Management stated that available cash, investments and credit capacity were sufficient to fund operations and capital requirements for the next 12 months, while noting that additional financing may be considered as the business grows.

Material Changes Versus the Prior Comparable Period

Trupanion moved from operating and net losses in Q2 2019 to operating and net income in Q2 2020; the six-month period also moved to modest profitability.
Revenue growth was driven by enrollment growth, higher revenue per pet and substantial growth in the other business segment.
Q2 subscription veterinary invoice expense per pet benefited from a temporary reduction in veterinary activity associated with COVID-19, increasing subscription gross margin by approximately one percentage point. Management stated that this benefit may not persist.
Accounts receivable increased to $80.7 million from $54.4 million at year-end, while deferred revenue increased to $75.7 million from $52.5 million.
Stock-based compensation expense increased to $4.0 million for the six months from $3.3 million. Approximately $22.5 million of additional stock-based compensation remained to be recognized for unvested awards as of June 30, 2020.
The company repurchased only 3,300 shares during the first six months and none during Q2 under its $15.0 million repurchase authorization.

Guidance, Outlook, Commentary and Risks

The filing does not provide a specific numerical revenue or earnings forecast. Management expects continued investment in member acquisition, member experience, technology and operations.
COVID-19 had not produced a material adverse impact through the filing date. Substantially all employees were working from home, cancellation processing was slowed, and approximately 1,600 cancellations were expected to shift from Q2 into Q3.
Management warned that economic conditions could reduce new enrollments and increase cancellations, while reduced veterinary activity could temporarily affect claims expense. The pandemic’s duration and effects remain uncertain.
Key risks include inaccurate veterinary invoice reserves, rising veterinary care costs, regulatory approval requirements for pricing and insurance practices, risk-based capital requirements, dependence on retention and acquisition economics, competition, cybersecurity and technology disruptions, and termination of other-business relationships.
The reserve for veterinary invoices was $24.4 million at June 30, 2020. Reserve estimates rely on actuarial assumptions and could materially affect future results if actual claims differ.
The company continues to address legacy inquiries from state insurance regulators regarding whether certain enrollment-support personnel required insurance licenses. Management believes it is adequately reserved and that the matters are not material.
The company adopted the expected credit loss standard on January 1, 2020; adoption had no material financial statement impact. Disclosure controls and procedures were evaluated as effective.

Investor Verification Priorities

Verify whether Q2’s claims-frequency benefit from COVID-19 reverses and how veterinary invoice expense per pet affects future gross margins.
Monitor subscription enrollment, retention, revenue per pet and pet acquisition cost to assess the sustainability of growth and customer economics.
Assess the quality and collectability of the $80.7 million accounts receivable balance and the timing of deferred-revenue recognition.
Review statutory capital and dividend restrictions at insurance subsidiaries, including the portion of reported liquidity unavailable for general corporate purposes.
Track credit-facility availability, covenant compliance and the effect of additional borrowing or equity financing on liquidity and dilution.
Evaluate regulatory inquiries, pricing approvals, licensing requirements and potential changes to insurance regulation.
Reconcile non-GAAP lifetime value and acquisition-cost metrics with GAAP results, noting that management’s calculations depend on estimates and may not be comparable with other companies.