Trupanion, Inc. 2014 Q3 Form 10-Q Summary
Business context and reporting period
Trupanion provides direct-to-consumer monthly medical-plan subscriptions for cats and dogs in the United States, Canada and Puerto Rico. The filing covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. The company operates subscription and other-business segments and completed its initial public offering in July 2014.
Financial performance and key metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Revenue | $30.3 million | $22.1 million | $84.0 million | $59.8 million |
| Gross profit | $4.4 million | $4.1 million | $14.4 million | $11.6 million |
| Gross margin | 14.7% | 18.6% | 17.1% | 19.3% |
| Operating loss | $(5.4) million | $(1.1) million | $(11.8) million | $(4.5) million |
| Net loss | $(8.5) million | $(1.2) million | $(16.9) million | $(5.0) million |
| Net loss per share | $(0.41) | $(0.87) | $(2.09) | $(3.84) |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $(9.7) million | $(1.1) million |
- Revenue grew 37% in Q3 and 40% in the first nine months. Subscription revenue increased 38% in Q3 and 37% year to date; other-business revenue increased 31% and 82%, respectively.
- Total pets enrolled reached 207,843 at September 30, up 30% from 160,065 a year earlier. Monthly adjusted revenue per pet was $44.98 in Q3, up 6%, while average monthly retention was 98.67% versus 98.64%.
- Claims expenses rose faster than revenue. Subscription claims represented 75% of subscription revenue in Q3 versus 70% in the prior-year quarter and 72% versus 69% for the nine-month periods.
- Operating expenses increased to $9.9 million in Q3 from $5.2 million and to $26.1 million for the nine months from $16.0 million. Technology and development and general and administrative expenses were the largest sources of growth.
- Q3 and nine-month results included stock-based compensation of $2.0 million and $3.2 million, respectively. Q3 general and administrative expense included $1.4 million related to IPO-contingent restricted stock vesting.
- As of September 30, cash and cash equivalents were $59.1 million, short-term fixed-maturity investments were $19.3 million, and total assets were $100.5 million. Total stockholders’ equity was $62.6 million, compared with a deficit of $33.0 million at December 31, 2013.
- Outstanding debt was $14.9 million under a revolving line of credit maturing July 2016. The company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Growth continued, but profitability weakened: Q3 gross margin declined to approximately 15% from 19%, and the operating-loss margin widened to approximately 18% from 5%.
- Claims frequency was higher than historical averages, partly because of initiatives intended to improve member experience. Management expects claims and cost-of-revenue ratios to remain elevated for several quarters while pricing changes reach members’ annual renewal dates.
- Sales and marketing expense increased 46% in Q3, while average pet acquisition cost increased 41% to $113. Management reported a lifetime-value-to-acquisition-cost ratio of 5.2:1.
- Technology and development expense increased 119% in Q3, reflecting claims-processing improvements, infrastructure investments and higher staffing. General and administrative expense increased 116%, primarily due to IPO-related stock compensation and public-company costs.
- The July IPO sold 8.2 million shares at $10.00 per share and generated approximately $72.8 million of net proceeds. Preferred stock and exchangeable shares converted into common stock.
- The company repaid a $29.0 million subordinated term loan and a $3.0 million term loan in July. The repayment caused $4.4 million of unamortized debt discounts and a $0.3 million prepayment fee to be recognized in interest expense.
Cash flow, liquidity, outlook and risks
For the first nine months, operating cash use was $9.7 million and investing cash use was $7.2 million, primarily for investments and property and equipment. Financing provided $61.0 million, principally from IPO proceeds, debt activity and release of restricted cash. Management stated that cash, cash equivalents and short-term investments should fund operations and statutory capital requirements for at least the next 12 months, but also noted that additional financing may be pursued and may not be available on acceptable terms.
No formal revenue or earnings guidance is provided in the filing. Management expects continued investment in member acquisition, technology, member experience and public-company infrastructure. It expects operating expenses to increase in the near term and historically negative operating cash flow to continue while the business expands.
- American Pet Insurance Company is subject to risk-based capital requirements. At December 31, 2013, it was below the No Action Level and submitted a capital plan to the New York Department of Financial Services. Growth may require additional restricted capital and could limit funds available for operations.
- The company has no reinsurance and therefore retains the full risk of adverse claims frequency or severity. Claims reserves were $5.4 million at September 30, 2014 and may prove insufficient.
- Regulatory matters include a California Department of Insurance notice of non-compliance and an ongoing Washington insurance-regulator examination. The company accrued $0.1 million for the California matter but could not estimate potential losses beyond recorded amounts.
- The company accrued $1.0 million for Canadian GST/HST, including interest, relating to intercompany fees from 2007 through 2013.
- The relationship with an unaffiliated managing general agent may be terminated with notice; it represented approximately 8.9% of nine-month 2014 revenue. The Canadian underwriting arrangement with Omega may also affect Canadian enrollment and renewals if terminated.
- Key risks include continued losses, rising acquisition costs, claims volatility, regulatory approvals for pricing, competition, technology and data-security failures, dependence on veterinary referrals, foreign-exchange exposure and the need for additional capital.
Important facts for investors to verify
- Whether revenue and enrollment growth can continue while claims expense ratios remain elevated.
- The adequacy of the $5.4 million claims reserve and the effect of the company’s lack of reinsurance.
- APIC’s subsequent risk-based capital status and the outcome of its New York regulatory capital plan.
- The status and potential financial impact of the California and Washington regulatory matters and Canadian GST/HST obligations.
- Whether cash resources remain sufficient given ongoing operating cash losses, statutory capital needs and planned technology and marketing investments.
- The sustainability of the reported 5.2:1 lifetime-value-to-acquisition-cost ratio as acquisition costs increase and lifetime value declines from $617 to $584.
- The impact of the January 2015 expiration of lockups covering approximately 19.4 million shares and the associated potential dilution or selling pressure.