TRUPANION, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview 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 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 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 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. We engage our “Territory Partners” to have face-to-face visits with veterinarians and their staff. Territory Partners are dedicated to cultivating direct veterinary relationships and building awareness of the benefits of high quality medical insurance to veterinarians and their clients. Veterinarians then educate pet owners, who visit our website or call our contact center to learn more about, and potentially enroll in, Trupanion. We also receive a significant number of new leads from existing members adding pets and referring their friends and family members. Our direct-to-consumer acquisition channels serve as important resources for pet owner education and drive new member leads and conversion. 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 targeted return on investment. Our Response to the COVID-19 Pandemic Due to the uncertainty caused by the COVID-19 pandemic, we continue to: • Protect our team. We instituted a work-from-home policy for substantially all employees in March 2020. This allowed responsible social distancing to keep our team safe. We are also providing technology support, training and other resources to support our team members during this unique time. • Leverage our data about COVID-19. 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 material COVID-19-related veterinary invoices. • Provide relief and support to members. We value our members and understand the economic and health challenges COVID-19 has created for many of them. We slowed our process on subscription cancellations related to payments that fail, reverting to our historical 60-day process. 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. We have not experienced a material adverse impact on our business due to COVID-19, but we are carefully monitoring new enrollments and retention, veterinary invoice expense, and other expenses, as well as the impact of COVID-19 on our partners. The impacts of COVID-19 and related economic conditions on our results are highly uncertain and in many ways outside of our control. 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. 15 Key Operating Metrics 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 Mar. 31, 2021 Dec. 31, 2020 Sept. 30, 2020 Jun. 30, 2020 Mar. 31, 2020 Dec. 31, 2019 Sept. 30, 2019 Jun. 30, 2019 Total Business: Total pets enrolled (at period end) 943,854 862,928 804,251 744,727 687,435 646,728 613,694 577,686 Subscription Business: Total subscription pets enrolled (at period end) 609,835 577,957 552,909 529,400 508,480 494,026 479,427 461,314 Monthly average revenue per pet $ 62.97 $ 62.03 $ 60.87 $ 59.40 $ 58.96 $ 58.58 $ 58.12 $ 57.11 Lifetime value of a pet, including fixed expenses $ 684 $ 653 $ 615 $ 597 $ 535 $ 523 $ 511 $ 482 Average pet acquisition cost (PAC) $ 279 $ 272 $ 261 $ 199 $ 247 $ 222 $ 208 $ 213 Average monthly retention 98.73 % 98.71 % 98.69 % 98.66 % 98.59 % 98.58 % 98.59 % 98.57 % Total pets enrolled. Total pets enrolled reflects the number of subscription pets or pets enrolled in one of the insurance products offered in our other business segment at the end of each period presented. We monitor total pets enrolled because it provides an indication of the growth of our consolidated business. Total subscription pets enrolled. Total subscription pets enrolled reflects the number of pets in active memberships at the end of each period presented. We monitor total subscription pets enrolled because it provides an indication of the growth of our subscription business. Monthly average revenue per pet. Monthly average revenue per pet is calculated as amounts billed in a given period for subscriptions divided by the total number of subscription pet months in the period. Total subscription pet months in a period represents the sum of all subscription pets enrolled for each month during the period. We monitor monthly average revenue per pet because it is an indicator of the per pet unit economics of our subscription business. Lifetime value of a pet, including fixed expenses. 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. Implied average subscriber life in months is calculated as the quotient obtained by dividing one by one minus the average monthly retention rate. We monitor lifetime value of a pet, including fixed expenses, to estimate the value we might expect from new pets over their implied average subscriber life in months, if they behave like the average pet in that respective period. When evaluating the amount of sales and marketing expenses we may want to incur to attract new pet enrollments, we refer to the lifetime value of a pet, including fixed expenses, as well as our estimated internal rate of return calculation for an average pet, which also includes an estimated surplus capital charge, to inform the amount of acquisition spend in relation to the estimated payback period. 16 Average pet acquisition cost. Average pet acquisition cost (PAC) is calculated as net acquisition cost divided by the total number of new subscription pets enrolled in that period. Net acquisition cost, a non-GAAP financial measure, is calculated in a reporting period as sales and marketing expense, excluding stock-based compensation expense and other business segment sales and marketing expense, offset by sign-up fee revenue. We exclude stock-based compensation expense because the amount varies from period to period based on number of awards issued and market-based valuation inputs. We offset sign-up fee revenue because it is a one-time charge to new members collected at the time of enrollment used to partially offset initial setup costs, which are included in sales and marketing expenses. 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 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 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. We monitor average monthly retention because it provides a measure of member satisfaction and allows us to calculate the implied average subscriber life in months. Non-GAAP Financial Measures We believe that using net acquisition cost to calculate and present certain of our other key metrics is helpful to our investors and an important tool for financial and operational decision-making and evaluating our operating results over different periods of time. Measuring net acquisition cost by removing stock-based compensation expense and other business segment sales and marketing expense offset by sign-up fee revenue provides for a more comparable metric across periods. This measure, which is a non-GAAP financial measure, may not provide information that is directly comparable to that provided by other companies in our industry. In addition, this measure excludes stock-based compensation expense, which has been, and is expected to continue to be for the foreseeable future, a significant recurring component of our sales and marketing expense. 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 table reconciles net acquisition cost to sales and marketing expense (in thousands) for each of the last eight fiscal quarters: Three Months Ended Mar. 31, 2021 Dec. 31, 2020 Sept. 30, 2020 Jun. 30, 2020 Mar. 31, 2020 Dec. 31, 2019 Sept. 30, 2019 Jun. 30, 2019 Sales and marketing expense $ 19,704 $ 14,809 $ 13,344 $ 9,242 $ 10,442 $ 9,212 $ 9,255 $ 8,757 Net of sign-up fee revenue (1,264) (919) (827) (781) (765) (730) (790) (734) Excluding: Stock-based compensation expense (2,731) (801) (741) (675) (556) (547) (577) (567) Other business segment sales and marketing expense (171) (201) (265) (191) (163) (152) (94) (38) Net acquisition cost $ 15,538 $ 12,888 $ 11,511 $ 7,595 $ 8,958 $ 7,783 $ 7,794 $ 7,418 Components of Operating Results General We operate in two business segments: subscription business and other business. 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. 17 Revenue We generate revenue in our subscription business segment primarily from subscription fees for our pet medical insurance. Fees are paid at the beginning of each subscription period, which automatically renews on a monthly basis. In most cases, our members authorize us to directly charge their credit card, debit card or bank account through automatic funds transfer. Subscription revenue is recognized on a pro rata basis over the monthly enrollment term. Membership may be canceled at any time without penalty, and we issue a refund for the unused portion of the canceled membership. 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 also includes revenue from other products and software solutions which have a different margin profile than our subscription business. Cost of Revenue Cost of revenue in each of our segments is comprised of the following: Veterinary invoice expense Veterinary invoice expense includes our costs to review veterinary invoices, administer the payments, and provide member services, and other operating expenses directly or indirectly related to this process. We also accrue for veterinary invoices that have been incurred but not yet received. This also includes amounts paid by unaffiliated general agents, and an estimate of amounts incurred and not yet paid for our other business segment. Other cost of revenue Other cost of revenue for the subscription business segment includes direct and indirect member service expenses, Territory Partner renewal fees, credit card transaction fees and premium tax expenses. Other cost of revenue for the other business segment includes the commissions we pay to unaffiliated general agents, costs to administer the programs in the other business segment and premium taxes on the sales in this segment. Operating Expenses 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, including third-party services. It also includes expenses associated with development of new products and offerings. General and Administrative General and administrative expenses consist primarily of personnel costs and related expenses for our finance, actuarial, human resources, regulatory, legal and general management functions, as well as facilities and professional services. Sales and Marketing Sales and marketing expenses primarily consist of the cost to educate veterinarians and consumers about the benefits of Trupanion, to generate leads and to convert leads into enrolled pets, as well as print, online and promotional advertising costs, and employee compensation and related costs. 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. 18 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. 19 Factors Affecting Our Performance Average monthly retention. Our performance depends on our ability to continue to retain our existing and newly enrolled pets and is impacted by our ability to provide a best-in-class value and member experience. Our ability to retain enrolled pets depends on a number of factors, including the actual and perceived value of our services and the quality of our member experience, the ease and transparency of the process for reviewing and paying veterinary invoices for our members, and the competitive environment. In addition, other initiatives across our business may temporarily impact retention and make it difficult for us to improve or maintain this metric. For example, if the number of new pets enrolled increases at a faster rate than our historical experience, our average monthly retention rate could be adversely impacted, as our retention rate is generally lower during the first year of member enrollment. Investment in pet acquisition. We have made and plan to continue to make significant investments to grow our member base. Our net acquisition cost and the number of new members we enroll depends on a number of factors, including the amount we elect to invest in sales and marketing activities in any particular period in the aggregate and by channel, the frequency of existing members adding a pet or referring their friends or family, effectiveness of our sales execution and marketing initiatives, changes in costs of media, the mix of our sales and marketing expenditures and the competitive environment. Our average pet acquisition cost has in the past significantly varied, and in the future may significantly vary, from period to period based upon specific marketing initiatives and estimated rates of return on pet acquisition spend. 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 estimated return on PAC spend both on a detailed level by acquisition channel and in the aggregate. Timing of initiatives. 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. 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. The relative mix of our business between the United States and Canada impacts the monthly average revenue per pet we receive. Prices for our plan in Canada are generally higher than in the United States (in local currencies), which is consistent with the relative cost of veterinary care in each country. As our mix of business between the United States and Canada changes, our metrics, such as our monthly average revenue per pet, and our exposure to foreign exchange fluctuations will be impacted. Any expansion into other international markets could have similar effects. Other business segment. 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. Accordingly, we cannot control the volume of business, even if a contract is not terminated. Loss of an entire program via contract termination could result in the associated policies and revenues being lost over a period of 12 to 18 months, which could have a material impact on our results of operations. We may enter into additional relationships in the future to the extent we believe they will be profitable to us, which could also impact our operating results. 20 Results of Operations The following tables set forth our results of operations for the periods presented both in absolute dollars and as a percentage of total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results. Three Months Ended March 31, 2021 2020 (in thousands) Revenue: Subscription business $ 113,292 $ 89,484 Other business 41,393 21,817 Total revenue 154,685 111,301 Cost of revenue: Subscription business (1) 95,537 73,422 Other business 38,048 20,027 Total cost of revenue 133,585 93,449 Operating expenses: Technology and development (1) 3,731 2,120 General and administrative (1) 7,216 4,860 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 (12,729) (1,010) Interest expense (2) 379 Other income, net (62) (282) 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 March 31, 2021 2020 (in thousands) Cost of revenue $ 3,234 $ 268 Technology and development 664 100 General and administrative 1,819 729 Sales and marketing 2,731 556 Total stock-based compensation expense $ 8,448 $ 1,653 21 Three Months Ended March 31, 2021 2020 (as a percentage of revenue) Revenue 100 % 100 % Cost of revenue 86 84 Operating expenses: Technology and development 2 2 General and administrative 5 4 Sales and marketing 13 9 Depreciation and amortization 2 1 Total operating expenses 22 17 Gain (loss) from investment in joint venture — — Operating loss (8) (1) Interest expense — — Other income, net — — Loss before income taxes (8) (1) Income tax (benefit) expense — — Net loss (8) % (1) % Stock-based compensation expense: Three Months Ended March 31, 2021 2020 (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, 2021 2020 (as a percentage of subscription revenue) Subscription business revenue 100 % 100 % Subscription business cost of revenue 84 82 22 Comparison of the Three Months Ended March 31, 2021 and 2020 Revenue Three Months Ended March 31, % Change 2021 2020 (in thousands, except percentages, pet and per pet data) Revenue: Subscription business $ 113,292 $ 89,484 27 % Other business 41,393 21,817 90 Total revenue $ 154,685 $ 111,301 39 Percentage of Revenue by Segment: Subscription business 73 % 80 % Other business 27 20 Total revenue 100 % 100 % Total pets enrolled (at period end) 943,854 687,435 37 Total subscription pets enrolled (at period end) 609,835 508,480 20 Monthly average revenue per pet $ 62.97 $ 58.96 7 Average monthly retention 98.73 % 98.59 % 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 $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. 23 Cost of Revenue Three Months Ended March 31, % Change 2021 2020 (in thousands, except percentages, pet and per pet data) Cost of Revenue: Subscription business: Veterinary invoice expense $ 83,726 $ 65,188 28 % Other cost of revenue 11,811 8,234 43 Total cost of revenue 95,537 73,422 30 Other business: Veterinary invoice expense 26,144 14,452 81 Other cost of revenue 11,904 5,575 114 Total cost of revenue $ 38,048 $ 20,027 90 Percentage of Revenue by Segment: Subscription business: Veterinary invoice expense 74 % 73 % Other cost of revenue 10 9 Total cost of revenue 84 82 Other business: Veterinary invoice expense 63 66 Other cost of revenue 29 26 Total cost of revenue 92 % 92 % Total pets enrolled (at period end) 943,854 687,435 37 Total subscription pets enrolled (at period end) 609,835 508,480 20 Monthly average revenue per pet $ 62.97 $ 58.96 7 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. 24 Technology and Development Expenses Three Months Ended March 31, % Change 2021 2020 (in thousands, except percentages) Technology and development $ 3,731 $ 2,120 76 % Percentage of total revenue 2 % 2 % 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 March 31, % Change 2021 2020 (in thousands, except percentages) General and administrative $ 7,216 $ 4,860 48 % Percentage of total revenue 5 % 4 % 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 March 31, % Change 2021 2020 (in thousands, except percentages, pet and per pet data) Sales and marketing $ 19,704 $ 10,442 89 % Percentage of total revenue 13 % 9 % Subscription Business: Total subscription pets enrolled (at period end) 609,835 508,480 20 Average pet acquisition cost (PAC) $ 279 $ 247 13 25 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 2021 2020 (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. 26 Liquidity and Capital Resources The following table summarizes our cash flows for the periods indicated (in thousands): Three months ended March 31, 2021 2020 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 (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) 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". 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. 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. In December 2020, we elected to terminate our line of credit facility and repaid all then outstanding obligations. Operating Cash Flows We derive operating cash flows from the sale of our subscription plans, which is used to pay veterinary invoices and other cost of revenue. 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. 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 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 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. Regulation 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. 27 APIC The majority of our investments are held by our insurance entities to satisfy risk-based capital requirements of the National Association of Insurance Commissioners (NAIC). The NAIC requirements provide a method for analyzing the minimum amount of risk-based capital (statutory capital and surplus plus other adjustments) appropriate for an insurance company to support its overall business operations, taking into account the risk characteristics of the company’s assets, liabilities and certain other items . An insurance company found to have insufficient statutory capital based on its risk-based capital ratio may be subject to varying levels of additional regulatory oversight depending on the level of capital inadequacy. APIC must hold certain capital amounts in order to comply with the statutory regulations and, therefore, we cannot use these amounts for general operating purposes without regulatory approval. As our business grows, the amount of capital we are required to maintain to satisfy our risk-based capital requirements may increase significantly. As of December 31, 2020, APIC was required to maintain at least $79.1 million of risk-based capital to avoid this additional regulatory oversight. As of that date, APIC maintained $93.2 million of risk-based capital. WICL Segregated Account AX WICL Segregated Account AX was established by WICL, with Trupanion, Inc. as the shareholder, to enter into a reinsurance agreement with Omega General Insurance Company. All of the assets and liabilities of WICL Segregated Account AX are legally segregated from other assets and liabilities within WICL, and all shares of the segregated account are owned by Trupanion, Inc. During February 2020, our parent entity received a dividend of $4.7 million from WICL Segregated Account AX as allowed under our agreements with WICL. As required by the Office of the Superintendent of Financial Institutions regulations related to our reinsurance agreement with Omega General Insurance Company, we are required to maintain a Canadian Trust account with the greater of CAD $2.0 million or 120% of unearned Canadian premium plus 20% of outstanding Canadian claims, including all incurred but not reported claims. As of December 31, 2020, the account held CAD $5.8 million. Though we are not directly regulated by the Bermuda Monetary Authority (BMA), WICL's regulation and compliance impacts us as it could have an adverse impact on the ability of WICL Segregated Account AX to pay dividends. WICL is regulated by the BMA under the Insurance Act of 1978 (Insurance Act) and the Segregated Accounts Company Act of 2000. The Insurance Act imposes on Bermuda insurance companies, solvency and liquidity standards, certain restrictions on the declaration and payment of dividends and distributions, certain restrictions on the reduction of statutory capital, and auditing and reporting requirements, and grants the BMA powers to supervise and, in certain circumstances, to investigate and intervene in the affairs of insurance companies. Under the Insurance Act, WICL, as a class 3 insurer, is required to maintain available statutory capital and surplus at a level equal to or in excess of a prescribed minimum established by reference to net written premiums and loss reserves. Under the Bermuda Companies Act 1981, as amended, a Bermuda company may not declare or pay a dividend or make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would after the payment be, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than its liabilities. The Segregated Accounts Company Act of 2000 further requires that dividends out of a segregated account can only be paid to the extent that the cell remains solvent and the value of its assets remain greater than the aggregate of its liabilities and its issued share capital and share premium accounts. Contractual Obligations 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 March 31, 2021, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020. 28 Critical Accounting Policies and Significant Estimates Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements, as well as the reported revenue and expenses during the reporting periods. Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Generally, we base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. There have been no material changes to our critical accounting policies and estimates as compared to those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020. 29 Item 3. 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 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.