Business Context and Reporting Period
Trupanion, Inc. provides medical insurance for cats and dogs in the United States, Canada and Puerto Rico. This unaudited Form 10-Q covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017. The company operates subscription and other business segments and remains an emerging growth company.
Financial Performance and Liquidity
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $69.8 million | $54.7 million | 27% |
| Gross profit | $11.1 million | $9.2 million | 21% |
| Gross margin | 16% | 17% | Down 1 percentage point |
| Operating loss | $1.5 million | $1.3 million | Loss increased $0.1 million |
| Net loss | $1.5 million | $1.5 million | Essentially unchanged |
| Net loss per diluted share | $0.05 | $0.05 | Unchanged |
| Cash provided by operations | $2.1 million | $1.9 million | Up $0.2 million |
- Subscription revenue was $61.5 million, up 22%; other business revenue was $8.2 million, up 83%.
- Subscription pets enrolled increased 15% to 385,640, while total pets enrolled increased 23% to 446,533. Monthly average revenue per pet rose 6% to $53.62, and average monthly retention improved slightly to 98.63%.
- Gross profit increased to $11.1 million, but gross margin declined because cost of revenue increased faster than revenue. Subscription cost of revenue was 83% of subscription revenue versus 82% in the prior-year quarter.
- Sales and marketing expense increased 45% to $5.9 million. Average pet acquisition cost rose 29% to $165 from $128, while reported lifetime value of a pet was $727.
- Cash, cash equivalents and short-term investments totaled $70.1 million at March 31, 2018. Cash, cash equivalents and restricted cash totaled $31.4 million.
- Long-term debt was $14.9 million on the balance sheet. The company had $15.0 million of aggregate borrowings under its revolving credit facility, with $13.0 million of available borrowing capacity, subject to facility limitations.
- Operating cash flow was positive, but financing activities provided $5.8 million, primarily from $5.5 million of additional credit-facility borrowings. Investing activities used $2.8 million, including $1.0 million for property and equipment.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by higher enrollment, increased revenue per pet and substantially higher other-business enrollment.
- Veterinary invoice expense increased 28% to $50.1 million, faster than revenue growth. The reserve for veterinary invoices was $13.5 million at quarter-end, compared with $12.8 million at December 31, 2017.
- Sales and marketing investment increased due to new marketing-channel testing and an 18% increase in related headcount. Technology and development expense declined 10%, partly because more project costs were capitalized.
- General and administrative expense increased 11% due primarily to higher occupancy costs and headcount, although it declined as a percentage of revenue.
- Debt increased from $9.3 million at December 31, 2017 to $14.9 million at March 31, 2018, net of financing fees.
- Common shares outstanding increased during the quarter, and 300,000 warrants were exercised in February 2018. Warrants for 510,000 shares remained outstanding and automatically convert to common stock in 2019.
Guidance, Outlook, Commentary, Risks and Unusual Items
- The filing does not provide a clear quantitative revenue or profitability forecast. Management stated that existing cash, investments and credit availability were sufficient to fund operations and capital requirements for the next 12 months, while noting that additional financing may be required as the business grows.
- Management intends to continue investing in member acquisition, member experience, technology and Territory Partners. These investments may increase acquisition costs and delay profitability.
- Insurance subsidiaries must maintain regulatory capital and assets for statutory and contractual requirements. At March 31, 2018, $19.7 million of cash and cash equivalents was segregated for insurance-claim payments, limiting its availability for general corporate purposes.
- Key operating risks include inaccurate pricing assumptions, higher-than-expected veterinary invoice costs, reserve estimation risk, regulatory approval of rate changes, insurance risk-based capital requirements, competition, member retention, rising acquisition costs, foreign-exchange exposure and reliance on veterinarians, Territory Partners and other referral sources.
- The company does not reinsure or cede its insurance risk, so adverse claim development could have a direct impact on results. Management noted that reserve estimates involve significant actuarial assumptions and may change materially.
- The company was in compliance with all financial and non-financial credit-facility covenants at quarter-end. The facility matures in December 2019 and bears interest at the greater of 4.5% or 1.25% plus the prime rate, which was 6.00% at March 31, 2018.
- The company recorded a $95,000 income-tax benefit in Q1 2018. Management noted that interpretations of the Tax Cuts and Jobs Act remain subject to additional guidance and could result in future adjustments.
- Management concluded that disclosure controls and procedures were effective and reported no material changes in internal control over financial reporting. Ordinary-course litigation and regulatory matters remain possible, but no specific matter was considered material at the filing date.
Most Important Facts for Investors to Verify
- Whether enrollment growth and the $727 reported lifetime value of a pet continue to justify the higher $165 acquisition cost.
- Whether veterinary invoice expense and reserve development stabilize sufficiently to restore or improve gross margins.
- Whether the company can reduce recurring net losses while continuing planned investments in sales, marketing and technology.
- The availability of corporate liquidity after considering restricted insurance-company cash, statutory capital requirements and credit-facility borrowing limits.
- Compliance with credit covenants and the company’s ability to refinance or repay the revolving facility before its December 2019 maturity.
- Future regulatory approval of pricing changes, required risk-based capital levels and the ability of insurance subsidiaries to upstream dividends.
- The impact of potential warrant conversion, stock-based compensation and other equity issuance on dilution.