TRUPANION, INC. quarterly report, Q1 FY2019

Trupanion, Inc. — Q1 2019 Form 10-Q Summary

Business context and reporting period

Trupanion provides medical insurance for cats and dogs in the United States, Canada and Puerto Rico through a subscription business and an “other business” segment that writes policies for third parties. This unaudited Form 10-Q covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018.

Financial performance and key metrics

Metric	Q1 2019	Q1 2018	Change
Revenue	$87.0 million	$69.8 million	Up 25%
Gross profit	$15.0 million	$11.1 million	Up 36%
Gross margin	17.3%	15.9%	Up approximately 1.4 points
Operating loss	$1.3 million	$1.5 million	Improved $0.2 million
Operating margin	(1.5%)	(2.1%)	Improved
Net loss	$1.3 million	$1.5 million	Improved $0.2 million
Net loss per share	$0.04	$0.05	Improved
Cash flow from operations	$4.0 million	$2.1 million	Up $1.9 million

Subscription revenue increased 21% to $74.2 million, while other-business revenue increased 55% to $12.8 million.
Subscription gross profit was $13.8 million, or 19% of subscription revenue, versus $10.5 million, or 17%, in the prior-year quarter. Other-business gross profit was $1.2 million, or approximately 9% of segment revenue.
Veterinary invoice expense increased 22% to $61.3 million. The consolidated reserve for veterinary invoices was $17.2 million at March 31, 2019, including $14.6 million for the subscription segment and $2.5 million for the other-business segment.
Operating expenses increased 30% to $16.3 million. Technology and development increased 23% to $2.7 million, general and administrative increased 22% to $5.4 million, and sales and marketing increased 39% to $8.2 million.
Stock-based compensation expense was $1.4 million, compared with $1.0 million in Q1 2018.
Total pets enrolled reached 548,002, up 23% year over year; subscription pets reached 445,148, up 15%. Monthly average revenue per pet increased 5% to $56.13, while average monthly retention was 98.58% versus 98.63%.
Average pet acquisition cost increased 24% to $205 from $165. Net acquisition cost increased to $7.0 million from $5.0 million.

Balance sheet, cash flow, debt and liquidity

Cash and cash equivalents were $26.6 million at March 31, 2019. Short-term investments were $61.6 million and long-term investments were $3.7 million.
Total assets were $221.3 million, compared with $207.5 million at December 31, 2018. Total liabilities were $91.3 million and stockholders’ equity was $130.0 million.
Long-term debt was $18.1 million on the balance sheet; borrowings under the revolving credit facility were approximately $18.2 million, net of financing fees.
The revolving credit facility had $50.0 million of capacity, $31.4 million of available borrowing capacity, and a June 2021 maturity date at March 31, 2019. On April 29, 2019, the maturity was extended to June 2022 and the interest-rate spread was reduced.
Net cash provided by operating activities was $4.0 million. Investing activities used $9.5 million, primarily for investment securities and a $1.5 million additional loan to a variable interest entity. Financing activities provided $5.4 million, including $5.2 million of debt financing.
Management stated that cash, cash equivalents, short-term investments and available credit were sufficient to fund operations and capital requirements for the next 12 months. Approximately $15.2 million of cash and cash equivalents was segregated in trust for veterinary invoice payments, and insurance-subsidiary assets are subject to regulatory capital and dividend restrictions.

Material changes versus the prior comparable period

Revenue growth accelerated through both higher subscription enrollment and significant growth in the other-business segment.
Gross margin improved as revenue growth exceeded the increase in cost of revenue, particularly in the subscription segment.
Despite higher sales and marketing investment, the operating and net losses narrowed.
Sales and marketing expense increased faster than revenue, and average pet acquisition cost rose materially, reflecting higher compensation costs and new marketing initiatives.
Operating cash flow nearly doubled, primarily from increased pet count, operating scale and timing differences between member collections and payments.
Short-term investments increased by approximately $7.1 million from year-end, while debt increased by approximately $5.2 million.

Guidance, outlook, commentary, risks and unusual items

The filing does not provide a clear numerical revenue, earnings or enrollment outlook for 2019. Management expects to continue investing in member acquisition, member experience, technology and growth.
Management emphasized that results depend on retention, pricing adequacy, veterinary invoice trends, regulatory approvals for rate changes, acquisition costs and the performance of referral channels.
The veterinary invoice reserve is actuarially estimated and may change materially if claims frequency, treatment costs, payment patterns or other assumptions differ from expectations.
APIC was required to maintain at least $53.4 million of risk-based capital as of December 31, 2018 and maintained $56.2 million. Continued enrollment growth may increase required regulatory capital and restrict the use of cash for general corporate purposes.
State regulators continue to review a legacy issue concerning whether certain employees assisting prospective members by telephone were required to hold insurance licenses. The company reported that prior matters were resolved in non-material amounts, believes it is adequately reserved, and believes it is compliant.
The company has commitments related to a variable interest entity, including a potential additional $4.0 million preferred-stock purchase through January 2020, a $2.5 million revolving credit line, and an option to purchase the entity in the future.
The company committed to contribute up to $2.2 million AUD to a joint venture upon specified milestones; $0.3 million AUD had been contributed by March 31, 2019.
Key risks include continued cumulative losses, rising acquisition costs, inability to achieve profitability, adverse claims experience, regulatory restrictions, capital requirements, competition, retention deterioration, dependence on veterinary referrals, technology or data-security failures, litigation and foreign-exchange exposure.
The company adopted the new lease standard on January 1, 2019, recording approximately $0.1 million of operating lease right-of-use assets and liabilities without a material effect on operations, equity or cash flows.
Management concluded that disclosure controls and procedures were effective as of March 31, 2019, with no material changes to internal control over financial reporting.

Most important facts for investors to verify

Whether enrollment growth and the 98.58% retention rate remain sufficient to offset the increase in average pet acquisition cost.
Whether veterinary invoice expense and reserve development remain consistent with pricing assumptions and do not compress subscription gross margins.
The amount of cash and investments that remain available for general corporate use after insurance-regulatory capital, trust and other restrictions.
Compliance with revolving-credit financial covenants, including revenue, claims-ratio, cash-flow and EBITDA-loss requirements.
APIC’s statutory capital and surplus relative to required risk-based capital as enrollment continues to grow.
The financial contribution, termination risk and margin profile of the other-business segment and its third-party relationships.
Progress toward profitability and whether additional equity or debt financing will be required to fund growth or regulatory capital needs.