Trupanion, Inc. — Q3 2020 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 primarily writes policies for third parties. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods.
Financial Performance and Key Metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $130.1 million | $99.3 million | $359.3 million | $278.5 million |
| Gross profit | $20.6 million | $17.4 million | $58.3 million | $47.2 million |
| Gross margin | 16% | 18% | 16% | 17% |
| Operating income (loss) | $(2.3) million | $0.8 million | $(1.8) million | $(2.6) million |
| Net income (loss) | $(2.6) million | $0.8 million | $(2.3) million | $(2.4) million |
| Net income (loss) per diluted share | $(0.07) | $0.02 | $(0.07) | $(0.07) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $17.6 million | $11.6 million |
- Revenue growth: Total revenue increased 31% year over year in Q3 and 29% for the nine-month period. Subscription revenue rose 20% in both periods, while other-business revenue increased 84% in Q3 and 78% for the nine months.
- Profitability: Revenue growth was offset by higher veterinary invoice expense and increased sales and marketing investment. Q3 operating results declined from income of $0.8 million to a loss of $2.3 million; nine-month operating loss improved from $2.6 million to $1.8 million.
- Segment margins: Subscription gross margin was 18% in Q3 and 19% for the nine months, compared with 19% and 18%, respectively, in 2019. Other-business gross margin was 8% in Q3 and for the nine months, versus 10% and 9% in 2019.
- Membership: Total pets enrolled reached 804,251, up 31% year over year. Subscription pets enrolled reached 552,909, up 15%. Monthly average revenue per pet increased 5% to $60.87 in Q3 and $59.77 for the nine months. Average monthly retention was 98.69%, compared with 98.59%.
- Unit economics: Average pet acquisition cost increased to $261 in Q3 from $208 and to $237 for the nine months from $209. Lifetime value of a pet, including fixed expenses, increased to $615 from $511 for the nine-month comparison.
- Cash and investments: At September 30, cash and cash equivalents were $35.2 million, short-term investments were $83.1 million, and long-term investments were $5.0 million. Management reported $118.3 million of cash, cash equivalents and short-term investments for liquidity purposes.
- Debt and liquidity: Long-term debt was $29.8 million, including $30.0 million of borrowings under a $50.0 million revolving credit facility, net of financing fees. Available borrowing capacity was $19.9 million. The facility matures in June 2022, and the company was in compliance with its covenants.
- Balance sheet: Total assets were $317.1 million and stockholders’ equity was $144.3 million at September 30, 2020. Deferred revenue increased to $87.0 million from $52.5 million at December 31, 2019.
Material Changes Versus the Prior Comparable Period
- Revenue growth accelerated through the expansion of both enrolled pets and pricing, but total gross margin declined by approximately two percentage points in Q3 and one percentage point for the nine months.
- Veterinary invoice expense increased 22% in the subscription segment during Q3, exceeding subscription revenue growth of 20%, reflecting higher veterinary-care cost and utilization per pet.
- Sales and marketing expense increased 44% in Q3 and 26% for the nine months as the company increased acquisition and conversion spending. Net acquisition cost rose to $28.1 million for the nine months from $22.2 million.
- Operating cash flow improved to $17.6 million from $11.6 million, supported by higher deferred revenue and reserve-related working-capital changes.
- Cash flow from investing remained negative at $18.6 million, primarily due to net purchases of investment securities and $4.5 million of property, equipment and intangible-asset purchases.
- Shares outstanding increased to 35.6 million at September 30, 2020 from 34.9 million at December 31, 2019, primarily through equity award activity. Only 3,300 shares were repurchased during the nine months.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Outlook: Management stated that cash, cash equivalents, short-term investments and available credit were expected to fund operations and capital requirements for the next 12 months. No specific revenue or earnings guidance is provided in the filing text.
- COVID-19: The company reported no material adverse impact through the filing date, but noted risks to enrollments, cancellations, veterinary invoice expense, partner productivity, employee productivity and cybersecurity. Approximately 1,300 cancellations were shifted from Q2 into Q3 because the company temporarily returned to a 60-day failed-payment cancellation process.
- Subsequent Aflac transaction: On October 26, 2020, Aflac invested $60.0 million for newly issued Trupanion shares at $55 per share and committed to invest an additional $140.0 million, subject to regulatory approvals and other conditions, expected by year-end 2020. The full commitment represents $200.0 million for 3,636,364 shares and includes a planned distribution alliance.
- Acquisitions: On October 30, 2020, Trupanion completed a software-company acquisition and an asset acquisition for approximately $48.2 million in total. Purchase accounting had not been completed when the filing was issued.
- Insurance and regulatory capital: A substantial portion of assets is held in regulated insurance entities and may not be available for general corporate purposes without regulatory approval. Growth may increase risk-based capital requirements.
- Claims reserves: The reserve for veterinary invoices was $28.8 million at September 30, 2020. Reserve estimates rely on actuarial assumptions and could materially affect future results if actual claims differ.
- Regulatory matters: The company continues to address legacy inquiries from state regulators regarding whether certain telephone enrollment activities required insurance licensing. Management believes it has adequately reserved and that the matters are not material.
- Key risks: Principal risks include continued operating losses, rising pet acquisition costs, veterinary-cost inflation, retention declines, competition, dependence on veterinary and strategic partners, insurance regulation, technology and cybersecurity failures, credit-facility covenants, foreign exchange exposure and execution risk related to Aflac and the acquisitions.
Most Important Facts for Investors to Verify
- Whether revenue growth can continue while veterinary invoice expense and acquisition costs rise faster than revenue.
- Whether the company can return to sustained operating profitability while funding member acquisition and technology investments.
- The availability of cash held within regulated insurance subsidiaries and the impact of future risk-based capital requirements.
- Completion of Aflac’s additional $140.0 million investment and the implementation and economics of the strategic alliance.
- The purchase-price allocation, integration costs and expected benefits of the approximately $48.2 million software and asset acquisitions.
- Actual development of veterinary invoice reserves, claims trends and the effect of COVID-19 or broader economic conditions on enrollments and cancellations.
- Potential changes in state insurance regulation, licensing requirements and the resolution of legacy regulator inquiries.