TRUPANION, INC. quarterly report, Q3 FY2023

Trupanion, Inc. — Form 10-Q Summary

Business context and reporting period

Trupanion provides medical insurance for cats and dogs in the United States, Canada, Europe, Puerto Rico, and Australia. Its two reporting segments are subscription business, primarily direct-to-consumer subscription fees, and other business, primarily policies underwritten for third parties and related insurance software products. This unaudited Form 10-Q covers the three and nine months ended September 30, 2023, compared with the corresponding 2022 periods.

Financial performance and key metrics

Metric	Q3 2023	Q3 2022	9M 2023	9M 2022
Revenue	$285.9 million	$233.8 million	$812.7 million	$659.2 million
Operating loss	$(3.5) million	$(11.9) million	$(41.1) million	$(33.8) million
Net loss	$(4.0) million	$(12.9) million	$(42.5) million	$(35.4) million
Net loss per diluted share	$(0.10)	$(0.32)	$(1.03)	$(0.87)
Operating cash flow	Not separately provided	Not separately provided	$1.1 million	$(9.0) million

Revenue increased 22% in Q3 and 23% for the first nine months. Subscription revenue grew 20% in Q3 and 19% year to date; other business revenue grew 27% and 32%, respectively.
Gross profit was approximately $35.2 million in Q3 and $91.0 million for the first nine months. Gross margin was approximately 12.3% in Q3 versus 12.8% in the prior-year quarter, and 11.2% year to date versus 13.4% in 2022.
Operating margin improved to approximately negative 1.2% in Q3 from negative 5.1%, while the nine-month operating margin was approximately negative 5.1%, broadly unchanged from 2022.
Interest expense rose to $3.1 million in Q3 and $8.4 million year to date, reflecting increased borrowings. Other income, net, was $2.5 million in Q3 and $6.4 million year to date, primarily offsetting part of the interest expense.
Total pets enrolled reached 1.712 million at September 30, up 19% year over year; subscription pets reached 969,322, up 20%. Monthly average revenue per subscription pet was $65.82 in Q3, up 3%, while average monthly retention was 98.55% versus 98.71%.
Average pet acquisition cost declined to $212 in Q3 and $232 for the first nine months, compared with $268 and $291, respectively, in the prior-year periods.
Cash, cash equivalents, and short-term investments totaled $265.9 million at September 30, 2023. Cash and cash equivalents were $150.3 million, short-term investments were $115.6 million, and restricted cash was $18.2 million.
Net cash provided by operating activities was $1.1 million for the first nine months, compared with cash usage of $9.0 million in 2022. Investing activities generated $25.1 million, while financing activities generated $58.6 million.
Property, equipment, and internal-use software purchases were $14.3 million year to date, primarily for member-experience software.

Debt, liquidity, and capital

Outstanding debt had a carrying value of $128.9 million, including $1.4 million current and $127.6 million long term. Principal borrowings totaled $135.0 million under the $150.0 million credit facility after a $25.0 million delayed draw in September 2023.
The credit facility bears floating-rate interest; the stated rate was approximately 10.54% at September 30, 2023. It is secured by substantially all company and subsidiary assets and includes financial and other covenants. The company reported compliance with all covenants.
Future principal payments totaled $133.7 million, including $72.1 million due in 2027 and $57.2 million thereafter.
Management believes existing liquidity and available borrowings are sufficient to fund operations and capital requirements for the next 12 months. The filing states that $15.0 million remained available under the credit facility.
Insurance entities held $228.0 million of cash, cash equivalents, and short-term investments and maintained $227.0 million of capital surplus, $60.8 million above estimated risk-based capital requirements. Transfers to the parent may be limited by regulation.

Material changes versus the prior comparable period

Revenue growth accelerated, but cost of revenue increased faster than subscription revenue. Subscription cost of revenue rose to 87% of subscription revenue for the first nine months from 84%, driven in part by a 6% increase in veterinary invoice expense per pet and veterinary-cost inflation.
New pet acquisition expense declined 21% in Q3 and 10% year to date as management emphasized more efficient acquisition channels. It represented 6% of total revenue in Q3 and 7% year to date, versus 10% in both prior-year periods.
General and administrative expense increased 23% in Q3 and 62% year to date. The year-to-date increase included $4.8 million of stock-based compensation related to executive departures and a $3.8 million non-recurring settlement for uncollected premiums associated with transitioning third-party underwriting to other insurers.
Technology and development expense declined 19% in Q3 and 15% year to date as certain previously pre-revenue initiatives began generating revenue.
Debt increased materially, contributing to higher interest expense. The company did not repurchase shares during the first nine months of 2023.
The reserve for veterinary invoices was $61.3 million at September 30, 2023, compared with $43.7 million at December 31, 2022. The company recorded unfavorable reserve development of $2.4 million in subscription business and $0.7 million in other business for the first nine months.

Guidance, outlook, commentary, and risks

The filing does not provide a specific quantitative revenue, earnings, or cash-flow forecast. Management’s stated priorities are continued member growth, retention, disciplined acquisition spending, product and member-experience investment, and pricing adjustments intended to achieve target returns. Management cautions that pricing changes may require regulatory approval and may lag changes in veterinary costs.

Key operating risks include persistent net losses, inability to achieve profitability, slower revenue or membership growth, lower retention, and inaccurate assumptions underlying lifetime value and pet acquisition spending.
Veterinary inflation, claim frequency and severity, reserve-estimation error, and increased use of direct-pay software could pressure margins and liquidity.
Insurance regulation may restrict pricing, capital deployment, dividends, licensing, underwriting activities, and transfers from insurance subsidiaries.
The other business segment depends on third-party relationships that may terminate or roll off; management expects a portion of this business to roll off beginning in 2023, although timing and extent are uncertain.
The company faces floating-rate debt exposure, covenant requirements, foreign-exchange risk, competitive pressure, cybersecurity and technology risks, litigation and regulatory proceedings, and potential limitations on the use of tax attributes.
Legal matters arise in the ordinary course, including coverage, employment, intellectual-property, contract, and regulatory matters. The company does not currently believe these matters are material individually or in the aggregate, but outcomes are inherently uncertain.
Disclosure controls and procedures were deemed effective as of September 30, 2023, and no material change in internal control over financial reporting was identified.

Important facts for investors to verify

Whether veterinary-cost inflation and unfavorable reserve development continue to reduce subscription margins.
Whether membership growth and 98.55% retention remain sustainable as the subscriber base expands.
Whether lower pet acquisition costs produce the expected returns and do not impair future growth.
The pace of debt repayment, floating-rate interest expense, covenant headroom, and remaining borrowing availability.
The availability of insurance-entity capital for parent-company liquidity and any regulatory restrictions on distributions.
The timing and financial impact of the expected other-business roll-off and any transition of Canadian underwriting to GPIC.
Whether the company can convert revenue growth into sustained positive operating cash flow and eventual profitability.