What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2020-10-30 compared with 2020-08-05 · 94 added, 85 removed, 360 unchanged (33% of the section changed)

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The scope, duration and magnitude of the direct and indirect effects of COVID-19 are evolving rapidly and in ways that are difficult, if possible, to anticipate.

Recent Developments

On October 26, 2020, we entered into a Strategic Alliance Agreement, Shareholder Agreement, and a Stock Purchase Agreement with Aflac Incorporated (“Aflac”).

The Strategic Alliance Agreement sets forth the structure for a distribution alliance between the parties (the “Alliance”).

This includes responsibilities of Aflac relating to brand, access and distribution,

responsibilities of Trupanion relating to marketing, product development and middle and back office functions, the intended go-to-market approach, the economic assumptions, and the intending timing.

The parties have agreed to negotiate in good faith and to act reasonably with each other in order to agree on such terms as are necessary to fully implement the Alliance.

To drive long term alignment, Aflac committed to invest $ 200.0 million cash in exchange for 3,636,364 newly issued shares of our common stock at a price of $ 55 per share, subject to a minimum holding period of three years.

The initial investment of $ 60.0 million closed on October 26, 2020.

The remaining $ 140.0 million is subject to regulatory approvals and is expected to close by the end of 2020.

On October 30, 2020, we completed an acquisition of an unaffiliated software company and also completed an asset acquisition for a total purchase price of approximately $ 48.2 million.

The acquired technology in both transactions was focused in the pet space and, along with the acquired personnel, is intended to enable us to improve our back-end software to help facilitate growth opportunities, additional products and geographies, as well as enhance our mobile platform.

Key Operating Metrics

The following tables set forth our key operating metrics for our subscription business, and total pets enrolled, for the six months ended June 30, 2020 and 2019, and for each of the last eight fiscal quarters.

Six Months Ended June 30,

The following tables set forth our key operating metrics for our subscription business, and total pets enrolled, for the nine months ended September 30, 2020 and 2019, and for each of the last eight fiscal quarters.

Nine Months Ended September 30,

Total Business:

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Three Months Ended

30, 2020 Jun.

30, 2020 Mar.

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31, 2019 Dec.

31, 2018 Sept.

Total Business:

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Average monthly retention is measured as the monthly retention rate of enrolled subscription pets for each applicable period averaged over the 12 months prior to the period end date.

As such, our average monthly retention rate as of June 30, 2020 is an average of each month’s retention from July 1, 2019 through June 30, 2020.

As such, our average monthly retention rate as of September 30, 2020 is an average of each month’s retention from October 1, 2019 through September 30, 2020.

We calculate monthly retention as the number of pets that remain after subtracting all pets that cancel during a month, including pets that enroll and cancel within that month, divided by the total pets enrolled at the beginning of that month.

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The presentation and utilization of non-GAAP financial measures is not meant to be considered in isolation or as a substitute for the directly comparable financial measures prepared in accordance with GAAP.

The following tables reconcile net acquisition cost to sales and marketing expense (in thousands) for the six months ended June 30, 2020 and 2019, and for each of the last eight fiscal quarters:

Six Months Ended June 30,

The following tables reconcile net acquisition cost to sales and marketing expense (in thousands) for the nine months ended September 30, 2020 and 2019, and for each of the last eight fiscal quarters:

Nine Months Ended September 30,

Sales and marketing expense $ 33,028 $ 26,239

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Three Months Ended

30, 2020 Jun.

30, 2020 Mar.

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31, 2019 Dec.

31, 2018 Sept.

Sales and marketing expense $ 13,344 $ 9,242 $ 10,442 $ 9,212 $ 9,255 $ 8,757 $ 8,227 $ 6,994

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Timing of initiatives.

Over time we plan to implement new initiatives to improve our member experience, make modifications to our subscription plan and find other ways to maintain a strong value proposition for our members.

Over time we plan to implement new initiatives to improve our member experience, make modifications to our subscription plan, improve our technology, and find other ways to maintain a strong value proposition for our members.

These initiatives will sometimes be accompanied by price adjustments, in order to compensate for an increase in benefits received by our members.

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The period-to-period comparison of financial results is not necessarily indicative of future results.

Three Months Ended June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2020 2019 2020 2019

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Gain (loss) from investment in joint venture 2 (59) (84) (331)

Operating income (loss) 1,509 (2,113) 499 (3,396)

Operating (loss) income (2,257) 843 (1,758) (2,553)

Interest expense 324 340 1,044 974

Other income, net (49) (297) (533) (1,094)

Income (loss) before income taxes 1,370 (1,977) 263 (3,233)

Income tax expense (benefit) 17 (46) 43 (6)

Net income (loss) $ 1,353 $ (1,931) $ 220 $ (3,227)

(Loss) income before income taxes (2,532) 800 (2,269) (2,433)

Income tax expense 26 18 69 12

Net (loss) income $ (2,558) $ 782 $ (2,338) $ (2,445)

(1) Includes stock-based compensation expense as follows:

Three Months Ended June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2020 2019 2020 2019

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Total stock-based compensation expense $ 2,430 $ 1,845 $ 6,310 $ 5,075

Three Months Ended June 30, Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

2020 2019 2020 2019

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Gain (loss) from investment in joint venture — — — —

Operating loss 1 (2) — (2)

Operating (loss) income (2) 1 — (1)

Interest expense — — — —

Other income, net — — — —

Loss before income taxes 1 (2) — (2)

(Loss) income before income taxes (2) 1 (1) (1)

Income tax expense — — — —

Net loss 1 % (2) % — % (2) %

Three Months Ended June 30, Six Months Ended June 30,

Net (loss) income (2) % 1 % (1) % (1) %

Three Months Ended September 30, Nine Months Ended September 30,

2020 2019 2020 2019

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Subscription business gross profit 18 % 19 % 19 % 18 %

Comparison of the Three and Six Months Ended June 30, 2020 and 2019

Three Months Ended June 30, % Change Six Months Ended June 30, % Change

Comparison of the Three and Nine Months Ended September 30, 2020 and 2019

Three Months Ended September 30, % Change Nine Months Ended September 30, % Change

2020 2019 2020 2019

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Average monthly retention 98.69 % 98.59 % 98.69 % 98.59 %

Three months ended June 30, 2020 compared to three months ended June 30, 2019.

Total revenue increased by $25.7 million, or 28%, to $117.9 million for the three months ended June 30, 2020.

Revenue from our subscription business segment increased by $14.7 million, or 19%, to $92.5 million for the three months ended June 30, 2020.

This increase in subscription business revenue was primarily due to a 15% increase in total subscription pets enrolled as of June 30, 2020 compared to June 30, 2019, and an increase in average revenue per pet of 4% for the same period.

Three months ended September 30, 2020 compared to three months ended September 30, 2019.

Total revenue increased by $30.8 million, or 31%, to $130.1 million for the three months ended September 30, 2020.

Revenue from our subscription business segment increased by $16.8 million, or 20%, to $99.4 million for the three months ended September 30, 2020.

This increase in subscription business revenue was primarily due to a 15% increase in total subscription pets enrolled as of September 30, 2020 compared to September 30, 2019, and an increase in average revenue per pet of 5% for the same period.

Increases in pricing were primarily due to the increased cost and utilization of veterinary care.

Revenue from our other business segment increased by $11.0 million, or 76%, to $25.5 million for the three months ended June 30, 2020, primarily due to an increase in enrolled pets in this segment.

Six months ended June 30, 2020 compared to six months ended June 30, 2019.

Total revenue increased by $50.0 million, or 28%, to $229.2 million for the six months ended June 30, 2020.

Revenue from our subscription business segment increased by $30.0 million, or 20%, to $181.9 million for the six months ended June 30, 2020.

Revenue from our other business segment increased by $14.1 million, or 84%, to $30.7 million for the three months ended September 30, 2020, primarily due to an 87% increase in enrolled pets in this segment.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019.

Total revenue increased by $80.9 million, or 29%, to $359.3 million for the nine months ended September 30, 2020.

Revenue from our subscription business segment increased by $46.7 million, or 20%, to $281.3 million for the nine months ended September 30, 2020.

Increases in pricing were primarily due to the increased cost and utilization of veterinary care.

Revenue from our other business segment increased by $20.1 million, or 74%, to $47.3 million for the six months ended June 30, 2020, primarily due to an increase in enrolled pets in this segment.

Revenue from our other business segment increased by $34.1 million, or 78%, to $78.0 million for the nine months ended September 30, 2020, primarily due to an increase in enrolled pets in this segment.

Cost of Revenue

Three Months Ended June 30, % Change Six Months Ended June 30, % Change

Three Months Ended September 30, % Change Nine Months Ended September 30, % Change

2020 2019 2020 2019

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Monthly average revenue per pet $ 60.87 $ 58.12 5 $ 59.77 $ 57.14 5

Three months ended June 30, 2020 compared to three months ended June 30, 2019.

Cost of revenue for our subscription business segment increased by $10.3 million, or 16%, to $74.6 million for the three months ended June 30, 2020.

This increase in subscription cost of revenue was primarily the result of a 15% increase in subscription pets enrolled and a 1% increase in veterinary invoice expense per pet.

Veterinary invoice per pet benefited from a temporary reduction in veterinary invoice during the quarter due to COVID-19, increasing our subscription gross margin by approximately 1% of revenue.

Total cost of revenue for our other business segment increased by $10.2 million, or 77%, to $23.5 million for the three months ended June 30, 2020, primarily due to the increase in enrolled pets in this segment.

Six months ended June 30, 2020 compared to six months ended June 30, 2019.

Cost of revenue for our subscription business segment increased by $23.4 million, or 19%, to $148.0 million for the six months ended June 30, 2020.

Three months ended September 30, 2020 compared to three months ended September 30, 2019.

Cost of revenue for our subscription business segment increased by $14.3 million, or 21%, to $81.1 million for the three months ended September 30, 2020.

This increase in subscription cost of revenue was primarily the result of a 15% increase in subscription pets enrolled and a 6% increase in veterinary invoice expense per pet, due to increases in the cost and utilization of veterinary care.

Total cost of revenue for our other business segment increased by $13.4 million, or 89%, to $28.4 million for the three months ended September 30, 2020, primarily due to the increase in enrolled pets in this segment.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019.

Cost of revenue for our subscription business segment increased by $37.7 million, or 20%, to $229.1 million for the nine months ended September 30, 2020.

This increase in subscription cost of revenue was primarily the result of a 15% increase in subscription pets enrolled and an increase of 4% in veterinary invoice expense per pet due to increases in the cost and utilization of veterinary care.

Total cost of revenue for our other business segment increased by $18.7 million, or 75%, to $43.5 million for the six months ended June 30, 2020, primarily due to the increase in enrolled pets in this segment.

Total cost of revenue for our other business segment increased by $32.1 million, or 81%, to $71.9 million for the nine months ended September 30, 2020, primarily due to the increase in enrolled pets in this segment.

Technology and Development Expenses

Three Months Ended June 30, % Change Six Months Ended June 30, % Change

Three Months Ended September 30, % Change Nine Months Ended September 30, % Change

2020 2019 2020 2019

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Percentage of total revenue 3 % 2 % 3 % 3 %

Three months ended June 30, 2020 compared to three months ended June 30, 2019.

Technology and development expenses increased by $0.4 million, or 16%, for the three months ended June 30, 2020.

The change was primarily due to a $0.4 million increase in compensation expenses and a $0.2 million increase in software and IT system expenditures, partially offset by a $0.2 million decrease in depreciation and amortization expenses.

Technology and development expenses remained consistent at 3% as a percentage of revenue year over year.

Six months ended June 30, 2020 compared to six months ended June 30, 2019.

Technology and development expenses increased by $0.6 million, or 11%, for the six months ended June 30, 2020.

The change was primarily due to a $0.7 million increase in compensation and third party contractor expenses, net of capitalization, and a $0.3 million increase in other technology expenditures, partially offset by a $0.4 million decrease in depreciation and amortization expenses.

Technology and development expenses remained consistent at 3% as a percentage of revenue year over year.

Three months ended September 30, 2020 compared to three months ended September 30, 2019.

Technology and development expenses increased by $1.1 million, or 49%, for the three months ended September 30, 2020.

The change was primarily due to a $0.2 million increase in compensation expenses, a $0.4 million increase in software and IT system expenditures, and a $0.4 million increase in depreciation and amortization expenses.

Technology and development expenses as a percentage of revenue slightly increased by less than 1% year over year.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019.

Technology and development expenses increased by $1.7 million, or 23%, for the nine months ended September 30, 2020.

The change was primarily due to a $1.0 million increase in compensation and third party contractor expenses, net of capitalization, and a $0.7 million increase in other technology expenditures.

Technology and development expenses remained relatively consistent at 3% as a percentage of revenue year over year.

General and Administrative Expenses

Three Months Ended June 30, % Change Six Months Ended June 30, % Change

Three Months Ended September 30, % Change Nine Months Ended September 30, % Change

2020 2019 2020 2019

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Percentage of total revenue 5 % 5 % 5 % 6 %

Three months ended June 30, 2020 compared to three months ended June 30, 2019.

General and administrative expenses increased by $0.9 million, or 17%, to $6.1 million for the three months ended June 30, 2020.

The change was primarily due to a $0.7 million increase in compensation expenses and a $0.3 million increase in depreciation and amortization, partially offset by a decrease of $0.1 million in legal, regulatory, and professional services fees.

General and administrative expenses decreased from 6% to 5% as a percentage of revenue for the three months ended June 30, 2020, as we experienced scale in our support functions.

Six months ended June 30, 2020 compared to six months ended June 30, 2019.

General and administrative expenses increased by $1.0 million, or 9%, to $11.6 million for the six months ended June 30, 2020.

This increase was primarily due to a $1.3 million increase in compensation expenses and a $0.3 million increase in depreciation and amortization, partially offset by a decrease of $0.5 million in legal, regulatory, and professional services fees.

General and administrative expenses decreased from 6% to 5% as a percentage of revenue for the six months ended June 30, 2020, as we experienced scale in our support functions.

Three months ended September 30, 2020 compared to three months ended September 30, 2019.

General and administrative expenses increased by $1.1 million, or 22%, to $6.1 million for the three months ended September 30, 2020.

The change was primarily due to a $0.5 million increase in compensation expenses and a $0.4 million increase in legal, regulatory, and professional services fees.

General and administrative expenses remained relatively consistent at 5% as a percentage of revenue year over year.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019.

General and administrative expenses increased by $2.1 million, or 13%, to $17.7 million for the nine months ended September 30, 2020.

This increase was primarily due to a $1.7 million increase in compensation expenses and a $0.4 million increase in depreciation and amortization expenses.

General and administrative expenses decreased from 6% to 5% as a percentage of revenue for the nine months ended September 30, 2020, as we experienced scale in our support functions.

Sales and Marketing Expenses

Three Months Ended June 30, % Change Six Months Ended June 30, % Change

Three Months Ended September 30, % Change Nine Months Ended September 30, % Change

2020 2019 2020 2019

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Average pet acquisition cost (PAC) $ 261 $ 208 25 $ 237 $ 209 13

Three months ended June 30, 2020 compared to three months ended June 30, 2019.

Sales and marketing expenses increased by $0.5 million, or 6%, to $9.2 million for the three months ended June 30, 2020.

The change was primarily due to a $0.9 million increase in compensation expenses and approximately $0.3 million increase in other sales and marketing initiatives, partially offset by a $0.7 million decrease in travel and conference expenses due to COVID-19.

Overall, sales and marketing expenses as a percentage of revenue decreased by 1.7% compared to prior year.

While we scaled back our pet acquisition expenditures in the current quarter due to COVID-19, our revenue growth remained strong, led by consistent pet enrollments and a higher retention in the current period.

Six months ended June 30, 2020 compared to six months ended June 30, 2019.

Sales and marketing expenses increased by $2.7 million, or 16%, to $19.7 million for the six months ended June 30, 2020.

The change was primarily due to a $2.1 million increase in compensation expense and a $1.2 million increase in other sales and marketing initiatives primarily related to increased investment in lead generation and conversion activities, partially offset by a $0.6 million decrease in travel and conference expenses due to COVID-19.

Sales and marketing expenses as a percentage of revenue decreased by 0.9% compared to prior year.

Revenue growth outpaced the increase in pet acquisition expenses in the current period, primarily due to consistent pet enrollments and a higher retention.

Three months ended September 30, 2020 compared to three months ended September 30, 2019.

Sales and marketing expenses increased by $4.1 million, or 44%, to $13.3 million for the three months ended September 30, 2020.

The change was primarily due to a $1.2 million increase in compensation expenses and approximately $2.9 million increase in other sales and marketing expenses to generate leads and increase conversion rates.

We increased our pet acquisition spend during the quarter to drive new pet enrollments and future growth.

As a result, sales and marketing expenses as a percentage of revenue increased by 1% compared to prior year.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019.

Sales and marketing expenses increased by $6.8 million, or 26%, to $33.0 million for the nine months ended September 30, 2020.

The change was primarily due to a $3.4 million increase in compensation expense and a $4.2 million increase in other sales and marketing expenses driven by new pets enrollment and increased spending on conversion initiatives, partially offset by a $0.8 million decrease in travel and conference expenses due to COVID-19.

Sales and marketing expenses as a percentage of revenue remained relatively consistent at 9% year over year.

Liquidity and Capital Resources

The following table summarizes our cash flows for the periods indicated (in thousands):

Six months ended June 30,

Nine months ended September 30,

Net cash provided by operating activities $ 17,580 $ 11,625

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Our primary requirements for liquidity are paying veterinary invoices, funding operations and capital requirements, investing in new member acquisition, investing in enhancements to our member experience, and servicing debt.

As of June 30, 2020, we had $105.2 million in cash, cash equivalents and short-term investments and $22.2 million available under our line of credit, which excluded $0.3 million reserved for ancillary services.

As of September 30, 2020, we had $118.3 million in cash, cash equivalents and short-term investments and $19.9 million available under our line of credit, which excluded $0.2 million reserved for ancillary services.

Most of the assets in our insurance subsidiary, American Pet Insurance Company (APIC), and our segregated cell business, Wyndham Insurance Company (SAC) Limited (WICL) Segregated Account AX, are subject to certain capital and dividend rules and regulations prescribed by jurisdictions in which they are authorized to operate.

As of June 30, 2020, total assets and liabilities held outside of our insurance entities were $94.4 million and $44.1 million, respectively, including $5.5 million of cash and cash equivalents that were segregated from other operating funds and held in trust for the payment of veterinary invoices on behalf of our insurance subsidiaries.

As of September 30, 2020, total assets and liabilities held outside of our insurance entities were $95.3 million and $51.2 million, respectively, including $5.5 million of cash and cash equivalents that were segregated from other operating funds and held in trust for the payment of veterinary invoices on behalf of our insurance subsidiaries.

For further information, refer to "—Regulation".

We believe our cash and cash equivalents, short-term investments and line of credit are sufficient to fund our operations and capital requirements for the next 12 months.

As we continue to grow, however, we may explore additional financing to fund our operations or to meet capital requirements.

As we continue to grow and consider strategic opportunities, however, we may explore additional financing to fund our operations or to meet capital requirements, including our financing with Aflac and related expenses associated with the Alliance.

Financing could include equity, equity-linked, or debt financing.

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We cannot predict the timing or extent of any repurchases of shares of common stock, as such repurchases will depend on a number of factors, some of which are beyond our control.

We did not repurchase any shares under this program during the quarter ended June 30, 2020.

We did not repurchase any shares under this program during the quarter ended September 30, 2020.

Operating Cash Flows

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Additionally, cash is used to support the growth of our business by reinvesting to acquire new pet enrollments and to fund projects that improve our members' experience.

Cash provided by operating activities was $7.8 million for the six months ended June 30, 2020 compared to $6.9 million for the six months ended June 30, 2019.

Cash provided by operating activities was $17.6 million for the nine months ended September 30, 2020 compared to $11.6 million for the nine months ended September 30, 2019.

The change was primarily driven by increased pet count and scale in our operating departments, as well as the timing differences between collections from members and payments of veterinary invoices and payments to vendors.

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Cash used in investing activities is primarily related to the net purchase of investments to increase our statutory capital.

Net cash used in investing activities decreased by $4.4 million for the six months ended June 30, 2020 compared to the same period in prior year, primarily due to $4.6 million lower net purchase of investments.

Net cash used in investing activities decreased by $4.2 million for the nine months ended September 30, 2020 compared to the same period in prior year, primarily due to a $3.1 million lower net purchase of investments.

Financing Cash Flows

Cash provided by financing activities was $2.4 million and $7.1 million for the six months ended June 30, 2020 and 2019, respectively.

The decrease of $4.7 million was primarily due to less drawn from our line of credit as well as a $2.5 million repayment in the current period.

Cash provided by financing activities was $7.3 million and $9.4 million for the nine months ended September 30, 2020 and 2019, respectively.

The decrease of $2.1 million was primarily due to $3.0 million less drawn from our line of credit as well as a $2.5 million repayment in the current period, partially offset by $3.0 million higher net proceeds from exercise of stock options.

Long-Term Debt

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We refer to this line of credit as our PWB credit facility.

The maximum amount available to us under the PWB credit facility, inclusive of any amounts outstanding under the revolving line of credit, is the lesser of $50.0 million or the total amount of cash and securities held by our insurance entities, less amounts outstanding relating to other ancillary services and letters of credit, totaling $0.3 million as of June 30, 2020.

Interest on the PWB credit facility accrues at a variable annual rate equal to the greater of 4.5%, or 0.75% plus the prime rate (4.50% at June 30, 2020).

Interest on the PWB credit facility accrues at a variable annual rate equal to the greater of 4.5%, or 0.75% plus the prime rate (4.50% at September 30, 2020).

The PWB credit facility requires us to maintain certain financial and non-financial covenants, including maintaining a minimum cash balance of $1.4 million in our account at WAB and/or WAB affiliates and other cash or investments of $2.1 million in our accounts at PWB.

As of June 30, 2020, we were in compliance with each of the financial and non-financial covenants.

As of September 30, 2020, we were in compliance with each of the financial and non-financial covenants.

Our obligations under the PWB credit facility are secured by substantially all of our assets and a pledge of certain of our subsidiaries’ stock.

As of June 30, 2020, we had $27.5 million in aggregate borrowings outstanding under the PWB credit facility.

As of June 30, 2020, our insurance entities, APIC and WICL Segregated Account AX, held $75.1 million in short-term investments and $99.1 million in other current assets, including $18.2 million held in cash and cash equivalents to be used for operating expenses of our insurance subsidiaries.

As of September 30, 2020, we had $30.0 million in aggregate borrowings outstanding under the PWB credit facility.

As of September 30, 2020, our insurance entities, APIC and WICL Segregated Account AX, held $83.0 million in short-term investments and $116.4 million in other current assets, including $23.1 million held in cash and cash equivalents to be used for operating expenses of our insurance subsidiaries.

Most of the assets in APIC and WICL Segregated Account AX are subject to certain capital and dividend rules and regulations prescribed by jurisdictions in which they are authorized to operate.

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We enter into long-term contractual obligations and commitments in the normal course of business, primarily debt obligations and non-cancellable vendor service agreements.

Management believes there have been no material changes to our contractual obligation disclosure as of June 30, 2020, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Management believes there have been no material changes to our contractual obligation disclosure as of September 30, 2020, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Critical Accounting Policies and Significant Estimates

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Quantitative and Qualitative Disclosures About Market Risks

Management believes there have been no material changes to our quantitative and qualitative disclosures about market risks during the six months ended June 30, 2020, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Management believes there have been no material changes to our quantitative and qualitative disclosures about market risks during the nine months ended September 30, 2020, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis