TRUPANION, INC. quarterly report, Q1 FY2017

Business Context and Reporting Period

Trupanion, Inc. provides medical insurance plans for cats and dogs in the United States, Canada and Puerto Rico. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016.

Key Financial Metrics

Metric	Q1 2017	Q1 2016	Change
Revenue	$54.7 million	$42.7 million	+28%
Gross profit	$9.2 million	$7.3 million	+25%
Gross margin	16.7%	17.1%	Down 0.4 percentage points
Operating loss	$1.3 million	$2.5 million	Improved by $1.2 million
Net loss	$1.5 million	$2.6 million	Improved by $1.1 million
Net loss per share	$0.05	$0.09	Improved
Adjusted EBITDA	$0.5 million	$(1.1) million	Improved by $1.5 million
Operating cash flow	$1.9 million	$(1.3) million	Improved by $3.2 million

Subscription revenue was $50.2 million, or 92% of total revenue, while other business revenue was $4.5 million. Subscription gross margin was approximately 17.9%, compared with 17.7% in the prior-year quarter. Other business gross margin declined to approximately 3.8% from 10.2%.

Total pets enrolled increased 19% year over year to 364,259; subscription pets increased 17% to 334,909.
Monthly average revenue per pet increased 9% to $50.50.
Average monthly retention was 98.58%, compared with 98.65% in Q1 2016.
Lifetime value per pet increased to $637 from $603, while average pet acquisition cost increased to $128 from $123; the LVP-to-PAC ratio improved to 5.0:1 from 4.9:1.
Claims expenses were $39.2 million, or 71.6% of revenue, compared with $30.6 million, or 71.7%, in Q1 2016.
Stock-based compensation expense was $0.8 million, and depreciation and amortization was $1.0 million.

Liquidity, Capital Resources and Balance Sheet

Cash and cash equivalents were $21.9 million at March 31, 2017; short-term investments were $30.8 million and long-term investments were $2.7 million.
Cash, cash equivalents and short-term investments totaled $52.7 million, according to management.
Operating cash flow was positive, but investing activities used $4.5 million, primarily for $2.7 million of notes receivable funding, net investment purchases and $0.5 million of property and equipment.
Total cash, cash equivalents and restricted cash declined $1.7 million during the quarter to $22.5 million.
The company reported $5.0 million of borrowings under its revolving credit facility, while the balance sheet reported $4.8 million of long-term debt.
The revolving facility was amended in March 2017, matures in December 2019, bears a variable rate equal to the greater of 4.5% or prime plus 1.25%, and had $20.5 million available at quarter-end.
Restricted cash was $0.6 million, and a $1.1 million standby letter of credit plus other requirements reduced borrowing availability.
Management stated that existing cash, investments and available credit should fund operations and statutory capital requirements for at least the next 12 months.
Insurance subsidiaries held substantial regulated assets, including $30.8 million of short-term investments. Capital and dividend restrictions may limit the parent company’s access to those funds.

Material Changes Versus the Prior Comparable Period

Revenue growth was driven by higher enrollment, a 9% increase in average revenue per pet, pricing increases reflecting higher veterinary costs and a positive foreign-exchange impact of approximately $0.4 million on Canadian revenue.
Operating expenses grew only 7% overall, versus 28% revenue growth. Sales and marketing increased 6%, technology and development increased 5%, and general and administrative expense increased 8%.
Operating and net losses narrowed substantially, and adjusted EBITDA improved from a loss to positive $0.5 million.
Operating cash flow turned positive, primarily reflecting increased revenue, operating leverage and increases in deferred revenue and claims reserves.
Other business gross profit fell 53% to $0.2 million as costs grew faster than revenue.
Interest expense increased to $0.1 million from $0.03 million, primarily due to higher debt balances.
Shares issued and outstanding increased during the quarter, partly reflecting stock option exercises; weighted-average shares increased to 29.3 million from 28.0 million.

Guidance, Outlook, Commentary and Risks

The filing does not provide a clear numerical revenue, earnings or cash-flow guidance range. Management expects to continue investing in member acquisition, new acquisition channels, Territory Partners, technology and member experience, which may increase acquisition costs and operating expenses. Management also expects technology and development and general and administrative expenses to decline as percentages of revenue as the business scales.

Claims reserves totaled $10.6 million at March 31, 2017. Actual claims severity, frequency, veterinary-cost inflation and incurred-but-not-reported claims could differ materially from estimates.
Management’s ability to achieve sustained profitability depends on enrollment growth, retention, pricing, claims experience, acquisition costs and operating leverage. The company had an accumulated deficit of $82.8 million.
Insurance regulation, required rate approvals, risk-based capital requirements and restrictions on dividends from insurance subsidiaries may constrain liquidity and growth investments. APIC maintained $30.5 million of risk-based capital at December 31, 2016 versus a stated $25.8 million no-action-level requirement.
Approximately 19.4% of Q1 revenue was generated in Canada, exposing results to foreign-exchange movements and Canadian regulatory and underwriting arrangements.
Veterinary practices represented more than half of enrollments and approximately 70% excluding existing members adding pets and referrals, creating concentration in referral channels.
The revolving credit facility contains financial and operating covenants. The company reported compliance with all covenants as of March 31, 2017.
The company remains exposed to competition, regulatory and legal proceedings, cybersecurity and system interruptions, payment-processing risks, key-person risk and the possibility that projected lifetime value does not justify member acquisition spending.
Disclosure controls and procedures were reported effective, with no material changes in internal control over financial reporting during the quarter.

Important Facts for Investors to Verify

Whether revenue growth and positive adjusted EBITDA translate into sustained GAAP profitability and recurring positive operating cash flow.
The adequacy of the $10.6 million claims reserve and the effect of future claims development on gross margins.
The reconciliation between the $4.8 million balance-sheet debt amount and the $5.0 million reported revolving-facility borrowings.
Availability of insurance-subsidiary cash and investments after statutory capital, trust, collateral and dividend restrictions.
Whether retention remains near 98.6% as enrollment continues to grow and whether the 5.0:1 LVP-to-PAC ratio is maintained.
The effect of pricing approvals, veterinary-cost inflation, Canadian foreign exchange and changes in insurance regulation.
Potential dilution from outstanding options, restricted stock and warrants; approximately 5.1 million potentially dilutive securities were excluded from diluted loss-per-share calculations at March 31, 2017.