What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-04-30 compared with 2020-10-30 · 133 added, 183 removed, 271 unchanged (54% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

We provide medical insurance for cats and dogs throughout the United States, Canada and Puerto Rico.

Our data-driven, vertically-integrated approach enables us to provide pet owners with what we believe is the highest value medical insurance for their pets, priced specifically for each pet’s unique characteristics.

Our growing and loyal member base provides us with highly predictable and recurring revenue.

We operate our business similar to other subscription-based businesses, with a focus on maximizing the estimated internal rate of return of an average pet.

We provide medical insurance for cats and dogs throughout the United States, Canada, Puerto Rico, and Australia.

Our data-driven, vertically-integrated approach enables us to provide pet owners with products that offer what we believe is the highest value medical insurance, priced specifically for each pet’s unique characteristics and coverage level.

Our growing and loyal membership base provides us with highly predictable and recurring revenue.

We operate our subscription business segment similar to other subscription-based businesses, with a focus on achieving a target margin prior to our pet acquisition expense and acquiring as many pets as possible at our targeted average estimated internal rate of return.

We operate in two business segments:

subscription business and other business.

We generate revenue in our subscription business segment primarily from subscription fees for our medical insurance, which we market to consumers.

We currently generate revenue in our subscription business segment from subscription fees for our “Trupanion” branded products.

Fees are paid at the beginning of each subscription period, which automatically renews on a monthly basis.

We generate revenue in our other business segment by writing policies on behalf of third parties.

We generate revenue in our other business segment primarily by writing policies on behalf of third parties.

We do not undertake the marketing efforts for these policies and have a business-to-business relationship with these third parties.

Our other business segment also includes revenue from companies or organizations that choose to offer medical insurance for cats and dogs as a benefit to their employees or members, and contracts include multiple pets.

The products in our other business segment may be materially different from our subscription business.

Our ultimate goal is to build the Trupanion brand by continuing to offer the highest value proposition in the industry and maintain strong alignment with the veterinary community.

We believe our activities in our other business segment benefit the overall market for pet medical insurance by expanding upon product options and distribution models within other market niches.

We generate leads for our subscription business through both third-party referrals and direct-to-consumer acquisition channels, which we then convert into members through our website and contact center.

Our other business segment also includes revenue from other products and software solutions that have a different margin profile from our subscription business.

We generate leads for our subscription business segment from a diverse set of member acquisition channels, which we then convert into members through our contact center, website and other direct-to-consumer activities.

These channels include leads from third-parties such as veterinarians and referrals from existing members.

Veterinary hospitals represent our largest referral source.

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• Protect our team.

We instituted a work-from-home policy for substantially all employees in early March.

We instituted a work-from-home policy for substantially all employees in March 2020.

This allowed responsible social distancing to keep our team safe.

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There has been understandable concern about whether COVID-19 is communicable to and from pets.

Using our extensive, proprietary database, we have closely monitored veterinary invoice data and shared our data with veterinarians, our members and the broader community that, to date, we have not seen any COVID-19-related veterinary invoices other than a few for COVID-19 testing.

• Provide relief and support to members.

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We slowed our process on subscription cancellations related to payments that fail, reverting to our historical 60-day process.

We estimate approximately 1,300 cancellations were shifted from the second quarter into the third quarter due to this change.

We also continue to provide a superior member experience with our claims, call center and broader team working tirelessly to ensure pets receive the care they need during this pandemic.

We also continue to provide a superior member experience with our claims, call center and broader team working to ensure pets receive the care they need during this pandemic.

• Carefully monitor the financial impact to our business.

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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 nine months ended September 30, 2020 and 2019, and for each of the last eight fiscal quarters.

Nine Months Ended September 30,

Total Business:

Total pets enrolled (at period end) 804,251 613,694

Subscription Business:

Total subscription pets enrolled (at period end) 552,909 479,427

Monthly average revenue per pet $ 59.77 $ 57.14

Lifetime value of a pet, including fixed expenses $ 615 $ 511

Average pet acquisition cost (PAC) $ 237 $ 209

Average monthly retention 98.69 % 98.59 %

The following table sets forth total pets enrolled and key operating metrics for our subscription business for each of the last eight fiscal quarters.

Three Months Ended

30, 2020 Jun.

30, 2020 Mar.

31, 2021 Dec.

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31, 2020 Dec.

31, 2019 Sept.

30, 2019 Jun.

Total Business:

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Lifetime value of a pet, including fixed expenses.

Lifetime value of a pet, including fixed expenses, is calculated based on gross profit from our subscription business segment for the 12 months prior to the period end date excluding stock-based compensation expense related to cost of revenue from our subscription business segment, sign-up fee revenue and the change in deferred revenue between periods.

This amount is also reduced by the fixed expenses related to our subscription business, which are the pro-rata portion of general and administrative and technology expenses, less stock-based compensation and depreciation, based on revenues.

Lifetime value of a pet, including fixed expenses, is calculated based on subscription revenue less cost of revenue from our subscription business segment for the 12 months prior to the period end date excluding stock-based compensation expense related to cost of revenue from our subscription business segment, sign-up fee revenue and the change in deferred revenue between periods.

This amount is also reduced by the fixed expenses related to our subscription business, which are the pro-rata portion of general and administrative and technology and development expenses, less stock-based compensation, based on revenues.

This amount, on a per pet basis, is multiplied by the implied average subscriber life in months.

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We exclude other business segment sales and marketing expense because that does not relate to subscription enrollments.

We monitor average pet acquisition cost to evaluate the efficiency of our sales and marketing programs in acquiring new members and measure effectiveness based on our desired return on investment.

We monitor average pet acquisition cost to evaluate the efficiency of our sales and marketing programs in acquiring new members and measure effectiveness using the ratio of our lifetime value of a pet to average pet acquisition cost, based on our desired return on investment.

Average monthly retention.

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 September 30, 2020 is an average of each month’s retention from October 1, 2019 through September 30, 2020.

As such, our average monthly retention rate as of March 31, 2021 is an average of each month’s retention from April 1, 2020 through March 31, 2021.

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 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

Net of sign-up fee revenue (2,373) (2,227)

Stock-based compensation expense (1,972) (1,573)

Other business segment sales and marketing expense (619) (262)

Net acquisition cost $ 28,064 $ 22,177

The following table reconciles net acquisition cost to sales and marketing expense (in thousands) for each of the last eight fiscal quarters:

Three Months Ended

30, 2020 Jun.

30, 2020 Mar.

31, 2021 Dec.

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31, 2020 Dec.

31, 2019 Sept.

30, 2019 Jun.

Sales and marketing expense $ 19,704 $ 14,809 $ 13,344 $ 9,242 $ 10,442 $ 9,212 $ 9,255 $ 8,757

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Other business segment sales and marketing expense (171) (201) (265) (191) (163) (152) (94) (38)

(265) (191) (163) (152) (94) (38) (130) (102)

Net acquisition cost $ 15,538 $ 12,888 $ 11,511 $ 7,595 $ 8,958 $ 7,783 $ 7,794 $ 7,418

Components of Operating Results

We operate in two segments:

We operate in two business segments:

subscription business and other business.

Our subscription business segment includes revenue and expenses related to monthly subscriptions for our pet medical insurance, which we market directly to consumers.

When we do not directly market to consumers, we classify the related revenue and expenses in our other business segment.

We currently generate revenue in our subscription business segment from subscription fees related to our “Trupanion” branded products.

Our other business segment includes revenue from other product offerings that generally have a business-to-business relationship and different margin profiles than our subscription segment, including revenue from writing policies on behalf of third parties and revenue from other products and software solutions.

We generate revenue in our subscription business segment primarily from subscription fees for our pet medical insurance.

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We generate revenue in our other business segment primarily from writing policies on behalf of third parties where we do not undertake the direct consumer marketing.

This segment includes the writing of policies that may be materially different from our subscription.

This segment also includes revenue from other products and software solutions which have a different margin profile than our subscription business.

Cost of Revenue

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Operating Expenses

Our operating expenses are classified into three categories:

technology and development, general and administrative, and sales and marketing.

For each category, the largest component is personnel costs, which include salaries, employee benefit costs, bonuses and stock-based compensation expense.

Our operating expenses are classified into four categories:

technology and development, general and administrative, sales and marketing, and depreciation and amortization.

For each category, excluding depreciation and amortization, the largest component is personnel costs, which include salaries, employee benefit costs, bonuses and stock-based compensation expense.

Technology and Development

Technology and development expenses primarily consist of personnel costs and related expenses for our technology staff, which includes information technology development and infrastructure support, third-party services, as well as depreciation of hardware and capitalized software.

It also includes expenses associated with development of new products and offerings.

General and Administrative

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Sales and marketing expenses are driven primarily by investments to acquire new members.

Depreciation and amortization

Depreciation and amortization expenses consist of depreciation of property, equipment, and software developed for internal use, as well as amortization of finite-lived intangible assets.

Gain (loss) from investment in joint venture

Gain (loss) from investment in joint venture consists of the share of income and losses from our equity method investment in a joint venture, as well as income and expenses associated with administrative services provided to the joint venture.

Stock-based compensation

Stock-based compensation is included in the cost and expense line items above.

Stock-based compensation will vary depending on corporate performance, measured by the estimated increase in our intrinsic value.

For example, when the company has delivered strong performance, stock compensation may increase as a result of incentive-based grants being awarded according to our equity incentive plan.

Factors Affecting Our Performance

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We also regularly test new member acquisition channels and marketing initiatives, which may be more expensive than our traditional marketing channels and may increase our average acquisition costs.

We continually assess our sales and marketing activities by monitoring the return on PAC spend both on a detailed level by acquisition channel and in the aggregate.

We continually assess our sales and marketing activities by monitoring the estimated return on PAC spend both on a detailed level by acquisition channel and in the aggregate.

Timing of initiatives.

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

The implementation of such initiatives may not always coincide with the timing of price adjustments, resulting in fluctuations in revenue and gross profit in our subscription business segment.

The implementation of such initiatives may not always coincide with the timing of price adjustments, resulting in fluctuations in revenue and profitability in our subscription business segment.

Geographic mix of sales.

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Other business segment.

Our other business segment primarily includes revenue and expenses related to policies written on behalf of third parties.

This segment includes the products that have been in the past, and may be in the future, materially different from our subscription.

Our other business segment primarily includes revenue and expenses from other product offerings that generally have a business-to-business relationship.

This segment includes products that have been in the past, and may be in the future, materially different from our subscription segment.

Our relationships in our other business segment are generally subject to termination provisions and are non-exclusive.

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

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

2020 2019 2020 2019

Three Months Ended March 31,

(in thousands)

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Total cost of revenue 133,585 93,449

Gross profit:

Subscription business 18,281 15,843 52,202 43,150

Other business 2,308 1,602 6,106 4,040

Total gross profit 20,589 17,445 58,308 47,190

Operating expenses:

Technology and development (1)

3,383 2,271 9,217 7,518

General and administrative (1)

6,121 5,017 17,737 15,655

Sales and marketing (1)

19,704 10,442

Depreciation and amortization 3,093 1,381

Total operating expenses 33,744 18,803

Gain (loss) from investment in joint venture (85) (59)

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

Operating loss (12,729) (1,010)

Interest expense (2) 379

Other income, net (62) (282)

(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)

Loss before income taxes (12,665) (1,107)

Income tax (benefit) expense (217) 26

Net loss $ (12,448) $ (1,133)

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

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

2020 2019 2020 2019

Three Months Ended March 31,

(in thousands)

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Total stock-based compensation expense $ 8,448 $ 1,653

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

2020 2019 2020 2019

Three Months Ended March 31,

(as a percentage of revenue)

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Cost of revenue 86 84

Gross profit 16 18 16 17

Operating expenses:

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Sales and marketing 13 9

Depreciation and amortization 2 1

Total operating expenses 22 17

Gain (loss) from investment in joint venture — —

Operating (loss) income (2) 1 — (1)

Operating loss (8) (1)

Interest expense — —

Other income, net — —

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

Income tax expense — — — —

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

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

2020 2019 2020 2019

(as a percentage of subscription revenue)

Loss before income taxes (8) (1)

Income tax (benefit) expense — —

Net loss (8) % (1) %

Stock-based compensation expense:

Three Months Ended March 31,

(as a percentage of revenue)

Cost of revenue 2 % — %

Technology and development — —

General and administrative 1 1

Sales and marketing 2 —

Total stock-based compensation expense 5 % 1 %

Three Months Ended March 31,

(as a percentage of

subscription revenue)

Subscription business revenue 100 % 100 %

Subscription business cost of revenue 84 82

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

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

Comparison of the Three Months Ended March 31, 2021 and 2020

Three Months Ended March 31, % Change

(in thousands, except percentages, pet and per pet data)

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Average monthly retention 98.73 % 98.59 %

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 $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.

Three months ended March 31, 2021 compared to three months ended March 31, 2020.

Total revenue increased by $43.4 million, or 39%, to $154.7 million for the three months ended March 31, 2021.

Revenue from our subscription business segment increased by $23.8 million, or 27%, to $113.3 million for the three months ended March 31, 2021.

This increase in subscription business revenue was primarily due to a 20% increase in total subscription pets enrolled as of March 31, 2021 compared to March 31, 2020, and an increase in average revenue per pet of 7% 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 $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.

Revenue from our other business segment increased by $19.6 million, or 90%, to $41.4 million for the three months ended March 31, 2021, primarily due to an 87% increase in enrolled pets in this segment.

Cost of Revenue

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

2020 2019 2020 2019

Three Months Ended March 31, % Change

(in thousands, except percentages, pet and per pet data)

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Total cost of revenue 95,537 73,422 30

Gross profit 18,281 15,843 15 52,202 43,150 21

Other business:

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Total cost of revenue $ 38,048 $ 20,027 90

Gross profit $ 2,308 $ 1,602 44 $ 6,106 $ 4,040 51

Percentage of Revenue by Segment:

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Total cost of revenue 84 82

Gross profit 18 19 19 18

Other business:

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Total cost of revenue 92 % 92 %

Gross profit 8 10 8 9

Total pets enrolled (at period end) 943,854 687,435 37

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Monthly average revenue per pet $ 62.97 $ 58.96 7

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 $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.

Three months ended March 31, 2021 compared to three months ended March 31, 2020.

Cost of revenue for our subscription business segment was $95.5 million for the three months ended March 31, 2021, compared to $73.4 million for the same period in the prior year.

Excluding stock-based compensation, cost of revenue for the subscription business was $92.2 million, or 81% of revenue in the first quarter of 2021, compared to 82% of revenue in prior year.

The increase of $22.1 million in subscription cost of revenue was primarily the result of a 20% increase in subscription pets enrolled and an increase of 6% in veterinary invoice expense per pet due to increases in the cost and utilization of veterinary care.

Additionally, stock-based compensation expense increased $3.0 million during the period due to grants related to performance in the prior year, including the full impact of one-time team grants during the period of $2.3 million.

The cost of revenue for our other business segment increased by $18.0 million, or 90%, to $38.0 million for the three months ended March 31, 2021, primarily due to the increase in enrolled pets in this segment.

Technology and Development Expenses

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

2020 2019 2020 2019

Three Months Ended March 31, % Change

(in thousands, except percentages)

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Percentage of total revenue 2 % 2 %

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.

Three months ended March 31, 2021 compared to three months ended March 31, 2020.

Technology and development expenses increased by $1.6 million, or 76%, to $3.7 million for the three months ended March 31, 2021.

Excluding stock-based compensation, technology and development expenses were $3.1 million, consistent with the prior period at 2% of revenue.

The increase in expense was primarily due to development expenses of $0.8 million related to new product offerings and $0.6 million of increased stock-based compensation during the period due to grants related to performance in the prior year, including the full impact of one-time team grants during the period of $0.3 million.

General and Administrative Expenses

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

2020 2019 2020 2019

Three Months Ended March 31, % Change

(in thousands, except percentages)

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Percentage of total revenue 5 % 4 %

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.

Three months ended March 31, 2021 compared to three months ended March 31, 2020.

General and administrative expenses increased by $2.4 million, or 48%, to $7.2 million for the three months ended March 31, 2021.

Excluding stock-based compensation, general and administrative expenses were $5.4 million, consistent with the prior period at 4% of revenue.

The increase in expense was primarily due to a $0.5 million increase in compensation expense related primarily to increased headcount, a $0.4 million increase in legal, tax and other professional service fees, and a $0.3 million increase in facilities-related expenses.

Additionally, stock-based compensation expense increased $1.1 million during the period due to grants related to performance in the prior year, including the full impact of one-time team grants during the period of $0.4 million.

Sales and Marketing Expenses

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

2020 2019 2020 2019

Three Months Ended March 31, % Change

(in thousands, except percentages, pet and per pet data)

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Average pet acquisition cost (PAC) $ 279 $ 247 13

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.

Three months ended March 31, 2021 compared to three months ended March 31, 2020.

Sales and marketing expenses increased by $9.3 million, or 89%, to $19.7 million for the three months ended March 31, 2021.

Excluding stock-based compensation, sales and marketing expenses were $17.0 million or 11% of revenue in the first quarter of 2021, compared to 9% of revenue in the prior year.

The increase was primarily due to new subscription pet enrollments increasing 54% year over year.

The increase in total expense was primarily due to a $4.0 million increase in sales and marketing expenses to generate leads and increase conversion rates and a $3.3 million increase in compensation expenses primarily related to headcount increases, partially offset by a $0.3 million decrease in travel and conference expenses.

Additionally, stock-based compensation expense increased $2.2 million during the period due to grants related to performance in the prior year, including the full impact of one-time team grants during the period of $1.3 million.

Depreciation and Amortization

Three Months Ended March 31, % Change

(in thousands, except percentages)

Depreciation and amortization $ 3,093 $ 1,381 124%

Percentage of total revenue 2 % 1 %

Depreciation and amortization expenses have been reclassified as a separate line item in the consolidated statement of operations and prior period amounts have been reclassified from their original presentation to conform to the current period presentation.

We elected to present depreciation and amortization expenses as a separate line item to better align with management's view of our operating results.

Three months ended March 31, 2021 compared to three months ended March 31, 2020.

Depreciation and amortization expense increased by $1.7 million, or 124%, to $3.1 million for the three months ended March 31, 2021.

The change was primarily due to a $1.1 million incremental amortization as a result of acquired intangible assets from the newly acquired software business.

Stock-based compensation

Three months ended March 31, 2021 compared to three months ended March 31, 2020.

Stock-based compensation is included in the cost and expense line items in the consolidated statements of operations.

Stock-based compensation expense was $8.4 million during the quarter, up from $1.7 million in the prior year period.

The amount of stock-based compensation recognized largely reflects the timing and vesting of our annual performance grants, including grants for the strong 2020 performance, calculated according to our equity incentive plan.

Of the $8.4 million, $4.3 million related to a one-time 2020 performance grant, shared with the entire team, which was fully recognized during the quarter.

Liquidity and Capital Resources

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

Nine months ended September 30,

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

Three months ended March 31,

Net cash provided by (used in) operating activities $ (1,735) $ 2,924

Net cash used in investing activities (4,602) (7,966)

Net cash provided by financing activities 7,275 9,374

Net cash provided by (used in) financing activities (643) 3,904

Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash, net 230 (809)

Net change in cash, cash equivalents and restricted cash $ (6,750) $ (1,947)

Our primary sources of liquidity are cash provided by operations and available borrowings on our line of credit.

We currently have a revolving line of credit of up to $50.0 million.

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 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 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.

As of March 31, 2021, we had $224.5 million in cash, cash equivalents and short-term investments.

Most of the assets in our insurance subsidiary, American Pet Insurance Company (APIC), and our segregated cell entity, 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 March 31, 2021, total assets and liabilities held outside of our insurance entities were $252.0 million and $30.3 million, respectively, including $7.2 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 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.

Our primary sources of liquidity are our existing cash, cash equivalents, and short-term investments, as well as cash provided by operations.

We believe these sources are sufficient to fund our operations and capital requirements for the next 12 months.

As we continue to grow and consider strategic opportunities, however, we may explore additional financing to fund our operations and growth or to meet capital requirements.

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

Additional financing may not be available to us on acceptable terms, or at all.

In November 2019, our board of directors approved a share repurchase program, pursuant to which we may repurchase up to $15.0 million of our outstanding shares over the 12 months following the approval.

Each quarter throughout this period, we intend to establish repurchase parameters reflecting our business’s capital allocation priorities, our stock price relative to our estimated intrinsic value, and general market conditions.

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 September 30, 2020.

In December 2020, we elected to terminate our line of credit facility and repaid all then outstanding obligations.

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 $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.

Changes in accounts receivable were primarily related to annual policies with monthly payment terms within our other business segment.

Net cash used in operating activities was $1.7 million for the three months ended March 31, 2021, compared to a $2.9 million net cash provided by operating activities for the three months ended March 31, 2020.

The change was primarily driven by increased pet acquisition spend during the quarter to drive new pet enrollments and future growth, as well as timing differences between collections from members and payments of veterinary invoices and payments to vendors.

Changes in accounts receivable and deferred revenue were primarily related to annual policies with monthly payment terms within our other business segment.

Investing Cash Flows

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 $4.2 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.

Net cash used in investing activities was $4.6 million for the three months ended March 31, 2021, primarily related to the net purchase of investments to increase our statutory capital, as well as purchases of property, equipment and intangible assets, primarily related to development of internal use software focused on new product initiatives and member experience improvements.

Financing Cash Flows

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

Pacific Western Bank Loan and Security Agreement

We have a syndicated loan agreement with Pacific Western Bank (PWB) and Western Alliance Bank (WAB), providing us a revolving line of credit of up to $50.0 million, with a maturity date in June 2022.

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 $0.2 million as of September 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 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 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.

Net cash used in financing activities was $0.6 million for the three months ended March 31, 2021, compared to $3.9 million net cash provided by financing activities during the same period in the prior year, primarily due to a $3.7 million decrease of borrowings from the line of credit facility.

In December 2020, we elected to terminate the facility and repaid all then outstanding obligations.

As of March 31, 2021, our insurance entities, APIC and WICL Segregated Account AX, held $91.3 million in short-term investments and $145.4 million in other current assets, including $26.8 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 September 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 March 31, 2021, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

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 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.

Management believes there have been no material changes to our quantitative and qualitative disclosures about market risks during the three months ended March 31, 2021, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

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