Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission File Number: 001-36537
TRUPANION, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
83-0480694
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
6100 4th Avenue S, Suite 200
Seattle, Washington 98108
(855) 727 - 9079
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. xYes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
 
Accelerated filer
x
 
Non-accelerated filer
o
(Do not check if smaller reporting company)
Smaller reporting company
o
 
 
 
 
Emerging growth company
x
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
As of October 26, 2017, there were approximately 30,039,804 shares of the registrant’s common stock outstanding.




TRUPANION, INC.
TABLE OF CONTENTS
 
 
Page
 
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
 




Note About Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “potentially,” “estimate,” “target,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan” and “expect,” and similar expressions that convey uncertainty of future events or outcomes, are intended to identify forward-looking statements.
These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Part II. Item 1A. “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
You should not rely on forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. We undertake no obligation to update publicly any forward-looking statements for any reason, except as required by law.
Unless otherwise stated or the context otherwise indicates, references to “Trupanion,” “we,” “us,” “our” and similar references refer to Trupanion, Inc. and its subsidiaries taken as a whole.
Investors and others should note that we announce material financial information to our investors using our investor relations website (http://investors.trupanion.com), Securities and Exchange Commission filings, press releases, public conference calls and webcasts. We use these channels, as well as social media, to communicate with our members and the public about our company, our services and other issues. It is possible that the information we post on social media could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in our company to review the information we post on the United States social media channels listed on our investor relations website.






PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Trupanion, Inc.
Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenue
$
63,118

 
$
48,359

 
$
176,122

 
$
136,890

Cost of revenue:
 
 
 
 
 
 
 
Claims expenses
43,453

 
34,253

 
123,649

 
97,323

Other cost of revenue
7,858

 
5,606

 
21,160

 
15,497

Gross profit
11,807

 
8,500

 
31,313

 
24,070

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
4,862

 
3,892

 
13,323

 
11,296

Technology and development
2,471

 
2,339

 
7,196

 
6,790

General and administrative
4,017

 
3,811

 
12,274

 
11,028

Total operating expenses
11,350


10,042

 
32,793

 
29,114

Operating income (loss)
457


(1,542
)
 
(1,480
)
 
(5,044
)
Interest expense
124

 
66

 
370

 
137

Other (income) expense, net
(99
)
 
16

 
(1,239
)
 
(39
)
Income (loss) before income taxes
432


(1,624
)
 
(611
)
 
(5,142
)
Income tax expense
26


13

 
54

 
31

Net income (loss)
$
406

 
$
(1,637
)
 
$
(665
)
 
$
(5,173
)

 
 
 
 
 
 
 
Net income (loss) per share:
 
 
 
 
 
 
 
Basic and diluted
$
0.01

 
$
(0.06
)
 
$
(0.02
)
 
$
(0.18
)
Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
30,037,282

 
28,732,417

 
29,500,958

 
28,362,084

Diluted
33,113,981

 
28,732,417

 
29,500,958

 
28,362,084


1



Trupanion, Inc.
Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
(unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)
$
406

 
$
(1,637
)
 
$
(665
)
 
$
(5,173
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Change in foreign currency translation adjustments
193

 
(96
)
 
317

 
204

Change in net gains on available-for-sale debt securities
1

 
25

 
9

 
33

Other comprehensive income (loss), net of taxes
194

 
(71
)
 
326

 
237

Comprehensive income (loss)
$
600

 
$
(1,708
)
 
$
(339
)
 
$
(4,936
)

2



Trupanion, Inc.
Consolidated Balance Sheets
(in thousands, except per share data)
 
September 30, 2017
 
December 31, 2016
Assets
(unaudited)
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
25,249

 
$
23,637

Short-term investments
34,031

 
29,570

Accounts and other receivables
20,315

 
10,118

Prepaid expenses and other assets
2,987

 
2,062

Total current assets
82,582

 
65,387

Restricted cash
600

 
600

Long-term investments, at fair value
3,084

 
2,579

Equity method investment

 
271

Property and equipment, net
7,958

 
8,464

Intangible assets, net
4,965

 
4,910

Other long-term assets
2,739

 
134

Total assets
$
101,928

 
$
82,345

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
2,327

 
$
2,006

Accrued liabilities and other current liabilities
7,813

 
5,416

Claims reserve
11,255

 
9,521

Deferred revenue
22,656

 
13,463

Total current liabilities
44,051

 
30,406

Long-term debt
7,299

 
4,767

Deferred tax liabilities
1,623

 
1,623

Other liabilities
1,003

 
834

Total liabilities
53,976

 
37,630

Stockholders’ equity:
 
 
 
Common stock: $0.00001 par value per share, 100,000,000 shares authorized at September 30, 2017 and December 31, 2016, 30,690,129 and 30,032,829 shares issued and outstanding at September 30, 2017; 30,156,247 and 29,498,947 shares issued and outstanding at December 31, 2016

 

Preferred stock: $0.00001 par value per share, 10,000,000 shares authorized at September 30, 2017 and December 31, 2016, and 0 shares issued and outstanding at September 30, 2017 and December 31, 2016

 

Additional paid-in capital
133,150

 
129,574

Accumulated other comprehensive loss
(51
)
 
(377
)
Accumulated deficit
(81,946
)
 
(81,281
)
Treasury stock, at cost: 657,300 shares at September 30, 2017 and December 31, 2016
(3,201
)
 
(3,201
)
Total stockholders’ equity
47,952

 
44,715

Total liabilities and stockholders’ equity
$
101,928

 
$
82,345


3



Trupanion, Inc.
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
 
 
 
 
Nine Months Ended September 30,
 
2017
 
2016
Operating activities
 
 
 
Net loss
$
(665
)
 
$
(5,173
)
Adjustments to reconcile net loss to cash provided by operating activities:
 
 
 
Depreciation and amortization
3,208

 
2,617

Stock-based compensation expense
2,564

 
2,215

Gain on sale of equity method investment
(1,036
)
 

Other, net
243

 
218

Changes in operating assets and liabilities:
 
 
 
Accounts and other receivables
(10,164
)
 
(2,023
)
Prepaid expenses and other assets
(297
)
 
217

Accounts payable, accrued liabilities, and other liabilities
2,122

 
(625
)
Claims reserve
1,639

 
2,043

Deferred revenue
9,075

 
2,079

Net cash provided by operating activities
6,689

 
1,568

Investing activities
 
 
 
Purchases of investment securities
(20,704
)
 
(15,992
)
Maturities of investment securities
15,878

 
12,577

Proceeds from sale of equity method investment
1,402

 

Purchases of property and equipment
(2,247
)
 
(1,546
)
Other investments
(2,762
)
 
(130
)
Net cash used in investing activities
(8,433
)
 
(5,091
)
Financing activities
 
 
 
Proceeds from exercise of stock options
2,082

 
2,736

Shares withheld to satisfy tax withholding
(1,170
)
 
(662
)
Proceeds from debt financing, net of financing fees
2,420

 
3,988

Payments on financing obligations
(412
)
 
(110
)
Net cash provided by financing activities
2,920

 
5,952

Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash, net
436

 
241

Net increase in cash, cash equivalents, and restricted cash
1,612

 
2,670

Cash, cash equivalents, and restricted cash at beginning of period
24,237

 
17,956

Cash, cash equivalents, and restricted cash at end of period
$
25,849

 
$
20,626

Supplemental disclosures
 
 
 
Noncash investing and financing activities:
 
 
 
Purchases of property and equipment included in accounts payable and accrued liabilities
531

 
81

Property and equipment acquired under capital lease
689

 
615


4



Trupanion, Inc.
Notes to the Consolidated Financial Statements (unaudited)
1. Nature of Operations and Significant Accounting Policies
Description of Business and Basis of Presentation
Trupanion, Inc. (collectively with its wholly-owned subsidiaries, the Company) provides medical insurance for cats and dogs throughout the United States, Canada and Puerto Rico.
The financial data as of December 31, 2016 was derived from the Company's audited consolidated financial statements. The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and, in management's opinion, have been prepared on the same basis as the audited financial statements and include all adjustments, consisting of normal recurring adjustments, necessary for the fair presentation of the Company's financial position, results of operations, comprehensive income (loss), and cash flows for the interim periods. These unaudited interim consolidated financial statements should be read in conjunction with the Company’s audited financial statements included in the Company’s Annual Report on Form 10-K, filed with the U.S Securities and Exchange Commission on February 15, 2017 (the 2016 10-K). The Company's accounting policies are described in Note 1 to the financial statements included in the 2016 10-K. Operating results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the full fiscal year or any other interim period.
Reclassifications
Certain prior year amounts have been reclassified within the Company’s consolidated financial statements from their original presentation to conform to the current period presentation.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from such estimates. See Note 1 to the audited financial statements included in the 2016 10-K for additional discussion of these estimates and assumptions.
Accumulated Other Comprehensive Loss
There were no reclassifications out of accumulated other comprehensive loss during the three and nine months ended September 30, 2017 and 2016.
Accounting Pronouncements Adopted During Period
In November 2015, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) amending the accounting for income taxes and requiring all deferred tax assets and liabilities be classified as non-current in the consolidated balance sheets. The Company adopted this ASU as of January 1, 2017 and has retrospectively applied the provisions of this standard.
In March 2016, the FASB issued an ASU amending the accounting for employee share-based payments, including income tax recognition and classification. The Company adopted this ASU as of January 1, 2017. As a result, the Company has elected to use actual forfeitures in the estimate of stock-based compensation expense. Additionally, the guidance related to the accounting for excess tax benefits and deficiencies resulted in an initial adjustment as of January 1, 2017 to the Company's net operating loss deferred tax asset to eliminate the Company's existing windfall pool amounting to $4.3 million, which was offset by an adjustment to the Company's valuation allowance. Finally, tax withholding of shares will be allowed up to the employee's maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award, subject to the Company's internal policies for making this election.
Recent Accounting Pronouncements
In February 2016, the FASB issued an ASU amending the lease presentation guidance. The ASU requires organizations that lease assets to recognize the rights and obligations created by those leases on the consolidated balance sheets. This ASU is effective for fiscal years beginning after December 15, 2018 including interim periods within that reporting period, with early adoption permitted. The Company plans to adopt this guidance as of January 1, 2019. The Company has determined this guidance will require recognition of a lease liability and corresponding asset on the consolidated balance sheets equal to the present value of minimum lease payments. The carrying amount of the asset is derived from the amount of the lease liability at the end of each reporting period. As of September 30, 2017 we are evaluating the impact of this on our consolidated financial statements and related disclosures.

5



2. Net Income (Loss) per Share
Basic net income (loss) per share is computed using the weighted-average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is calculated using the weighted-average number of shares of common stock plus, when dilutive, potential common shares outstanding using the treasury-stock method. Potential common shares outstanding include stock options, unvested restricted stock, and warrants.
The components of basic and diluted earnings per share were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except per share data)
Basic earnings per share:
 
 
 
 
 
 
 
Net income (loss)
$
406

 
$
(1,637
)
 
$
(665
)
 
$
(5,173
)
Shares used in computation:
 
 
 
 
 
 
 
Weighted average common shares outstanding
30,037,282

 
28,732,417

 
29,500,958

 
28,362,084

Basic earnings per share
$
0.01

 
$
(0.06
)
 
$
(0.02
)
 
$
(0.18
)
 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
Net income (loss)
$
406

 
$
(1,637
)
 
$
(665
)
 
$
(5,173
)
Shares used in computation:
 
 
 
 
 
 
 
Weighted average common shares outstanding
30,037,282

 
28,732,417

 
29,500,958

 
28,362,084

Stock options
2,618,567

 

 

 

Restricted stock units
919

 

 

 

Warrants
457,213

 

 

 

Weighted average number of shares
33,113,981

 
28,732,417

 
29,500,958

 
28,362,084

Diluted earnings per share
$
0.01

 
$
(0.06
)
 
$
(0.02
)
 
$
(0.18
)
The following potentially dilutive equity securities were not included in the diluted earnings per common share calculation because they would have had an antidilutive effect:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Stock options
480,360

 
4,354,494

 
4,118,884

 
4,354,949

Restricted stock awards and units

 
355,329

 
234,758

 
355,329

Warrants

 
869,999

 
810,000

 
869,999


6



3. Investment Securities
The amortized cost, gross unrealized holding gains and losses, and fair value of available-for-sale and short-term investments by major security type and class of security were as follows as of September 30, 2017 and December 31, 2016 (in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Holding
Gains
 
Gross
Unrealized
Holding
Losses
 
Fair
Value
As of September 30, 2017
 
 
 
 
 
 
 
       Available-for-sale:
 
 
 
 
 
 
 
Foreign deposits
$
2,083

 
$

 
$

 
$
2,083

Municipal bond
1,000

 
1

 

 
1,001

 
$
3,083

 
$
1

 
$

 
$
3,084

       Short-term investments:
 
 
 
 
 
 
 
              U.S. treasury securities
$
5,787

 
$

 
$
(2
)
 
$
5,785

              Certificates of deposit
690

 

 

 
690

              U.S. government funds
27,554

 

 

 
27,554

 
$
34,031


$

 
$
(2
)

$
34,029

 
 
 
 
 
 
 
 
 
Amortized
Cost
 
Gross
Unrealized
Holding
Gains
 
Gross
Unrealized
Holding
Losses
 
Fair
Value
As of December 31, 2016
 
 
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
 
 
Foreign deposits
$
1,587

 
$

 
$

 
$
1,587

Municipal bond
1,000

 

 
(8
)
 
992

 
$
2,587


$

 
$
(8
)

$
2,579

Short-term investments:
 
 
 
 
 
 
 
U.S. treasury securities
$
5,791

 
$

 
$

 
$
5,791

Certificates of deposit
707

 

 

 
707

U.S. government funds
23,072

 

 

 
23,072

 
$
29,570


$

 
$


$
29,570

Maturities of debt securities classified as available-for-sale were as follows (in thousands):
 
September 30, 2017
 
Amortized
Cost
 
Fair
Value
Available-for-sale:
 
 
 
Due after one year through five years
$
2,083

 
$
2,083

Due after five years through ten years
1,000

 
1,001

 
$
3,083

 
$
3,084

The Company evaluated its securities for other-than-temporary impairment and considers the decline in market value for the securities to be primarily attributable to current economic and market conditions. For debt securities, the Company does not intend to sell, nor is it more likely than not that the Company will be required to sell, the securities prior to the recovery of the amortized cost basis which may be at maturity.

7



4. Fair Value
The following table summarizes, by major security type, the Company's assets that are measured at fair value on a recurring basis, and placement within the fair value hierarchy (in thousands):
 
As of September 30, 2017
 
Fair Value
 
Level 1
 
Level 2
Assets
 
 
 
 
 
Restricted cash
$
600

 
$
600

 
$

Foreign deposits
2,083

 
2,083

 

Municipal bond
1,001

 

 
1,001

Money market funds
5,679

 
5,679

 

Total
$
9,363

 
$
8,362

 
$
1,001

 
 
 
 
 
 
 
As of December 31, 2016
 
Fair Value
 
Level 1
 
Level 2
Assets
 
 
 
 
 
Restricted cash
$
600

 
$
600

 
$

Foreign deposits
1,587

 
1,587

 

Municipal bond
992

 

 
992

Money market funds
7,033

 
7,033

 

Total
$
10,212

 
$
9,220

 
$
992

The Company measures the fair value of restricted cash, foreign deposits, and money market funds based on quoted prices in active markets for identical assets. The fair value of the municipal bond is based on either recent trades in inactive markets or quoted market prices of similar instruments and other significant inputs derived from or corroborated by observable market data.
As of September 30, 2017, the Company's other long-term assets balance included a $2.6 million note receivable, recorded at its estimated collectible amount, plus accrued interest. The Company estimates that the carrying value of the note receivable approximates the fair value. The estimated fair value represents a Level 3 measurement within the fair value hierarchy, and is based on market interest rates and the assessed creditworthiness of the third party.
The Company estimates the fair value of long-term debt based upon rates currently available to the Company for debt with similar terms and remaining maturities. This is a Level 3 measurement. Based upon the terms of the debt, the carrying amount of long-term debt approximated fair value at September 30, 2017 and December 31, 2016.
5. Debt
The Company has a revolving line of credit of up to $30.0 million, secured by any and all interests in the Company's assets that are not otherwise restricted. Interest on the revolving line of credit is payable monthly at the greater of 4.5%, or 1.25% plus the prime rate. The borrowing agreement includes other ancillary services and letters of credit of up to $4.5 million and $3.0 million as of September 30, 2017 and December 31, 2016, respectively. The facility also requires a deposit of restricted cash of $0.6 million. The agreement was amended during the current year to extend the maturity date to December 2019. The credit agreement requires the Company to comply with various financial and non-financial covenants. As of September 30, 2017 and December 31, 2016, the Company was in compliance with all covenants.
Borrowings on the revolving line of credit are limited to the lesser of $30.0 million and the total amount of cash and securities held by the Company's insurance subsidiaries (American Pet Insurance Company and Wyndham Insurance Company (SAC) Limited Segregated Account AX). As of September 30, 2017, available borrowing capacity on the line of credit was $21.0 million, with an outstanding balance of $1.5 million for ancillary services and letters of credit, and borrowings under the facility of $7.5 million, recorded net of financing fees of $0.2 million.

8



6. Commitments and Contingencies
From time to time, the Company is subject to litigation matters and claims arising from the ordinary course of business. The Company records a provision for a liability relating to legal matters when it is both probable that a material liability has been incurred and the amount of the loss can be reasonably estimated. At this time, the Company does not believe any such matters to be material individually or in the aggregate. These views are subject to change following the outcome of future events or the results of future developments.
7. Stock-Based Compensation
The following table presents information regarding stock options granted, exercised and forfeited for the periods presented:
 
Number Of Options
 
Weighted-Average Exercise Price
 
Aggregate Intrinsic Value
 
 
 
 
 
(in thousands)
Outstanding as of December 31, 2016
4,123,023

 
$
5.06

 
$
43,185

Granted
648,589

 
17.61

 
 
Exercised
(581,865
)
 
3.58

 
8,134

Forfeited
(70,863
)
 
11.56

 
 
Outstanding as of September 30, 2017
4,118,884

 
7.13

 
79,408

 
 
 
 
 
 
Vested and Exercisable at September 30, 2017
2,975,063

 
$
4.23

 
$
65,994

As of September 30, 2017, the stock options outstanding had a weighted-average remaining contractual life of 5.7 years.
Stock-based compensation expense includes stock options and restricted stock awards and units granted to employees and non-employees and has been reported in the Company’s consolidated statements of operations as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Claims expenses
$
101

 
$
74

 
$
260

 
$
189

Other cost of revenue
69

 
9

 
172

 
26

Sales and marketing
165

 
172

 
550

 
419

Technology and development
57

 
67

 
166

 
158

General and administrative
503

 
454

 
1,416

 
1,423

Total stock-based compensation expense
$
895

 
$
776

 
$
2,564

 
$
2,215

As of September 30, 2017, for all employees, the Company had 1,124,951 unvested stock options and 234,758 restricted stock awards and units that are expected to vest. Total stock-based compensation cost of $6.8 million related to unvested awards not yet recognized is expected to be recognized over a weighted-average period of approximately 2.8 years.

8. Claims Reserve
The claims reserve includes unpaid claims and claims adjustment expenses and an estimate of claims that have been incurred but not yet reported (IBNR) to the Company. The estimate, which involves actuarial projections, is based on management's assessment of facts and circumstances currently known, and assumptions about anticipated claims patterns, including expected future trends in the size and frequency of the average claim. Reserve estimates are continually refined as claims are reported and settled. Changes in management's assumptions and estimates may have a relatively large impact to the claims reserve and associated expense.
This estimate is made for each of the Company's two segments, subscription business and other business. The subscription business segment includes monthly subscriptions related to the Company’s medical plan which are marketed directly to consumers, while the other business segment includes all other business that is not directly marketed to consumers.

9



Summarized below are the changes in the total liability for the Company's subscription business segment:
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
 
(in thousands)
Claims reserve at beginning of year
 
$
8,538

 
$
5,384

Claims incurred during the period related to:
 
 
 
 
Current year
 
113,833

 
90,188

Prior years
 
(85
)
 
521

Total claims incurred
 
113,748

 
90,709

Claims paid during period related to:
 
 
 
 
Current year
 
104,501

 
82,761

Prior years
 
7,533

 
5,681

Total claims paid
 
112,034

 
88,442

Non-cash claims expense
 
306

 
279

Claims reserve at end of period
 
$
9,946

 
$
7,372


The Company’s claim reserve for the subscription business segment increased $1.4 million from $8.5 million at December 31, 2016 to $9.9 million at September 30, 2017. This change was comprised of $113.7 million in claims expense incurred during the period less $112.0 million in claims expense paid during the period. The $113.7 million in claims expense incurred includes a reduction of $0.1 million to the reserves relating to prior years, which is the result of ongoing analysis of recent claims trends. 
Summarized below are the changes in total liability for the Company's other business segment:
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
 
(in thousands)
Claims reserve at beginning of year
 
$
983

 
$
890

Claims incurred during the period related to:
 
 
 
 
Current year
 
10,074

 
6,718

Prior years
 
(173
)
 
(104
)
Total claims incurred
 
9,901

 
6,614

Claims paid during period related to:
 
 
 
 
Current year
 
8,786

 
5,765

Prior years
 
789

 
749

Total claims paid
 
9,575

 
6,514

Non-cash claims expense
 

 

Claims reserve at end of period
 
$
1,309

 
$
990


The Company’s claim reserve for the other business segment increased $0.3 million from $1.0 million at December 31, 2016 to $1.3 million at September 30, 2017. This change was comprised of $9.9 million in claims expense incurred during the period less $9.6 million in claims expense paid during the period. The $9.9 million in claims expense incurred includes a reduction of $0.2 million to the reserves relating to prior years, which is the result of ongoing analysis of recent claims trends. 



10



Claims Reserve by Loss Year
The total claims reserve as of September 30, 2017 for the subscription business segment relates to activity incurred during the years as follows (in thousands):
 
As of September 30, 2017
Year Incurred
 
2015
$
192

2016
727

2017
9,027

 
$
9,946

The total claims reserve as of September 30, 2017 for the other business segment relates to activity incurred during the years as follows (in thousands):
 
As of September 30, 2017
Year Incurred
 
2015
$
2

2016
19

2017
1,288

 
$
1,309

9. Equity Method Investment
In June 2017, the Company sold its share of an investment previously accounted for under the equity method. The sale resulted in a gain of $1.0 million recorded within other income on the consolidated statement of operations for the nine months ended September 30, 2017.

11



10. Segments
The Company has two segments: subscription business and other business. The subscription business segment includes monthly subscriptions related to the Company’s medical plan which are marketed directly to consumers, while the other business segment includes all other business that is not directly marketed to consumers.
The chief operating decision maker uses two measures to evaluate segment performance: revenue and gross profit. Additionally, other operating expenses, such as sales and marketing expenses, are allocated to each segment and evaluated when material. Interest and other expenses and income taxes are not allocated to the segments, nor included in the measure of segment profit or loss. The Company does not analyze discrete segment balance sheet information related to long-term assets.
Revenue and gross profit of the Company’s segments were as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
Subscription business
$
56,493

 
$
44,629

 
$
159,363

 
$
125,934

Other business
6,625

 
3,730

 
16,759

 
10,956

 
63,118

 
48,359

 
176,122

 
136,890

Claims expenses:
 
 
 
 
 
 
 
Subscription business
39,761

 
32,088

 
113,748

 
90,709

Other business
3,692

 
2,165

 
9,901

 
6,614

 
43,453

 
34,253

 
123,649

 
97,323

Other cost of revenue:
 
 
 
 
 
 
 
Subscription business
5,454

 
4,344

 
15,304

 
12,084

Other business
2,404

 
1,262

 
5,856

 
3,413

 
7,858

 
5,606

 
21,160

 
15,497

Gross profit:
 
 
 
 
 
 
 
Subscription business
11,278

 
8,197

 
30,311

 
23,141

Other business
529


303

 
1,002

 
929

 
11,807


8,500

 
31,313

 
24,070

Sales and marketing:
 
 
 
 
 
 
 
Subscription business
4,811

 
3,829

 
13,161

 
11,140

Other business
51

 
63

 
162

 
156

 
4,862

 
3,892

 
13,323

 
11,296

Technology and development
2,471

 
2,339

 
7,196

 
6,790

General and administrative
4,017

 
3,811

 
12,274

 
11,028

Operating income (loss)
$
457


$
(1,542
)
 
$
(1,480
)
 
$
(5,044
)
The following table presents the Company’s revenue by geographic region of the member (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
United States
$
50,506

 
$
38,799

 
$
141,946

 
$
110,024

Canada
12,612

 
9,560

 
34,176

 
26,866

Total revenue
$
63,118

 
$
48,359

 
$
176,122

 
$
136,890

Substantially all of the Company’s long-lived assets were located in the United States as of September 30, 2017 and December 31, 2016.

12



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We provide a medical insurance plan 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 plan for their pets, using a pricing model that is based on the estimated cost specific to each pet’s unique characteristics plus a standard margin. 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 lifetime value of each pet while sustaining a favorable ratio of lifetime value relative to pet acquisition cost, based on our desired return on investment.
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 plan, which we market to consumers. Our medical plan automatically renews on a monthly basis and members pay the subscription fee at the beginning of each subscription period, in most cases by authorizing 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. 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 provide different coverage and may have materially different terms and conditions than our subscription medical plan.
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. Veterinary practices represent our largest referral source. We engage a national referral network of partners, which we refer to as our Territory Partners, who are paid fees based on activity in their regions. Our Territory Partners are dedicated to cultivating direct veterinary relationships and building awareness of the benefits that our medical plan offers 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, our medical plan. 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 continuously evaluate the effectiveness of our member acquisition channels and marketing initiatives based upon their return on investment, which we measure by comparing the ratio of the lifetime value of a pet generated through each specific channel or initiative to the related acquisition cost.
Our revenue increased from $136.9 million for the nine months ended September 30, 2016 to $176.1 million for the nine months ended September 30, 2017, representing 29% year-over-year growth. We have made and expect to continue to make substantial investments in member acquisition and in expanding our operations. For the nine months ended September 30, 2017 and 2016, we had a net loss of $0.7 million and $5.2 million, respectively. As of September 30, 2017, our accumulated deficit was $81.9 million.

13



Key Operating Metrics
The following tables set forth our key operating metrics for the nine-month periods ended September 30, 2017 and 2016 and for each of the last eight fiscal quarters.
 
Nine Months Ended September 30,
 
2017
 
2016
Total pets enrolled (at period end)
404,069

 
334,070

Total subscription pets enrolled (at period end)
359,102

 
312,282

Monthly average revenue per pet
$
51.67

 
$
47.33

Lifetime value of a pet (LVP)
$
701

 
$
624

Average pet acquisition cost (PAC)
$
141

 
$
120

Average monthly retention
98.61
%
 
98.61
%

 
Three Months Ended
 
Sept. 30, 2017
 
Jun. 30, 2017
 
Mar. 31, 2017
 
Dec. 31, 2016
 
Sept. 30, 2016
 
Jun. 30, 2016
 
Mar. 31, 2016
 
Dec. 31, 2015
Total pets enrolled (at period end)
404,069

 
383,293

 
364,259

 
343,649

 
334,070

 
320,896

 
307,298

 
291,818

Total subscription pets enrolled (at period end)
359,102

 
346,409

 
334,909

 
323,233

 
312,282

 
299,856

 
287,123

 
272,636

Monthly average revenue per pet
$
52.95

 
$
51.47

 
$
50.50

 
$
49.17

 
$
48.37

 
$
47.39

 
$
46.12

 
$
45.48

Lifetime value of a pet (LVP)
$
701

 
$
654

 
$
637

 
$
631

 
$
624

 
$
622

 
$
603

 
$
591

Average pet acquisition cost (PAC)
$
151

 
$
143

 
$
128

 
$
133

 
$
120

 
$
118

 
$
123

 
$
132

Average monthly retention
98.61
%
 
98.57
%
 
98.58
%
 
98.60
%
 
98.61
%
 
98.64
%
 
98.65
%
 
98.64
%
Total pets enrolled. Total pets enrolled reflects the number of pets subscribed to either our plan or 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 subscribed to the plan marketed by us to consumers 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 month 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 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 business.
Lifetime value of a pet. Lifetime value of a pet (LVP) is calculated in part based on the average monthly 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, 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 LVP to assess how much lifetime value we might expect from new pets over their implied average subscriber life in months and to evaluate the amount of sales and marketing expenses we may want to incur to attract new pet enrollments.

14



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 expenses, excluding stock-based compensation expense, offset by sign-up fee revenue and other business segment sales and marketing expenses. We offset sales and marketing expenses with sign-up fee revenue since it is a one-time charge to new members used to partially offset initial setup costs, which are included in sales and marketing expenses. We monitor average pet acquisition cost to evaluate the efficiency of our sales and marketing programs and measure return on acquisition spend.
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, 2017 is an average of each month’s retention from October 1, 2016 through September 30, 2017. 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 acquisition cost and net acquisition cost to calculate and present certain of our other key metrics is helpful to our investors. These measures, which are non-GAAP financial measures, are not prepared in accordance with U.S. GAAP. We define acquisition cost as sales and marketing expenses, excluding stock-based compensation expense. We define net acquisition cost as acquisition cost net of sign-up fee revenue and other business segment sales and marketing expenses.
Our non-GAAP financial measures may not provide information that is directly comparable to that provided by other companies in our industry as other companies in our industry may calculate or use non-GAAP financial measures differently. In addition, there are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with GAAP, may be different from non-GAAP financial measures used by other companies and exclude expenses that may have a material impact on our reported financial results. 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. We urge our investors to review the reconciliation of our non-GAAP financial measures to the most directly comparable GAAP financial measures in our consolidated financial statements that is included below, and not to rely on any single financial or operating measure to evaluate our business.
Because of varying available valuation methodologies, subjective assumptions and the variety of equity instruments that can impact a company’s non-cash expenses, we believe that providing non-GAAP financial measures such as acquisition cost and net acquisition cost, allows for more meaningful comparisons between our operating results from period to period. We net sign-up fees with sales and marketing expenses in our calculation of net acquisition cost because we collect it from new members at the time of enrollment and consider it to be an offset to a portion of our sales and marketing expenses. We believe this allows us to calculate and present acquisition cost, net acquisition cost and the related financial measures we derive from them, in a consistent manner across periods. Our non-GAAP financial measures and the related financial measures we derive from them are important tools for financial and operational decision-making and for evaluating our own operating results over different periods of time.

15



The following tables reflect the reconciliation of acquisition cost and net acquisition cost to sales and marketing expense:
 
Nine Months Ended September 30,
 
2017
 
2016
 
(in thousands)
Sales and marketing expense
$
13,323

 
$
11,296

Excluding:
 
 
 
    Stock-based compensation expense
(550
)
 
(419
)
Acquisition cost
12,773

 
10,877

Net of:
 
 
 
    Sign-up fee revenue
(1,619
)
 
(1,547
)
    Other business segment sales and marketing expense
(162
)
 
(156
)
Net acquisition cost
$
10,992

 
$
9,174

 
Three Months Ended
 
Sept. 30, 2017
 
Jun. 30, 2017
 
Mar. 31, 2017
 
Dec. 31, 2016
 
Sept. 30, 2016
 
Jun. 30, 2016
 
Mar. 31, 2016
 
Dec. 31, 2015
 
(in thousands)
Sales and marketing expense
$
4,862

 
$
4,372

 
$
4,089

 
$
3,951

 
$
3,892

 
$
3,564

 
$
3,840

 
$
3,919

Excluding:
 
 

 
 
 
 
 
 
 
 
 
 
 
 
    Stock-based compensation expense
(165
)
 
(198
)
 
(187
)
 
(113
)
 
(172
)
 
(165
)
 
(82
)
 
(104
)
Acquisition cost
4,697

 
4,174

 
3,902

 
3,838

 
3,720

 
3,399

 
3,758

 
3,815

Net of:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Sign-up fee revenue
(558
)
 
(517
)
 
(544
)
 
(526
)
 
(525
)
 
(495
)
 
(527
)
 
(506
)
    Other business segment sales and marketing expense
(51
)
 
(63
)
 
(48
)
 
(62
)
 
(63
)
 
(55
)
 
(38
)
 
(8
)
Net acquisition cost
$
4,088

 
$
3,594

 
$
3,310

 
$
3,250

 
$
3,132

 
$
2,849

 
$
3,193

 
$
3,301

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 maintain the retention rate of enrolled pets may be affected by a number of factors, including the actual and perceived value of our services and the quality of our member experience, our claims payment process and the competitive environment. In addition, 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, 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 the actual or expected relationship to LVP 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 ratio of LVP to PAC and the return on PAC spend both on a detailed level by acquisition channel and in the aggregate.

16



Timing of initiatives. Over time we plan to implement new initiatives to improve our member experience, make modifications to our medical plan 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 gross profit 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 revenue has grown faster in the United States compared to Canada, this geographic shift in the mix of business has reduced the growth in our monthly average revenue per pet. In addition, as our mix of revenue changes between the United States and Canada, our exposure to foreign exchange fluctuations will be impacted.
Other business segment. Our other business segment primarily includes revenue and expenses related to policies written on behalf of third parties where we do not undertake the direct consumer marketing. This segment includes the writing of policies that provide different coverage and may have materially different terms and conditions than our subscription medical plan. 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.
Basis of Presentation
General
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 medical plan, which we market to consumers. Our other business segment includes revenue and expenses related to our other operations that are not directly marketed to consumers. We report our financial information in accordance with U.S. GAAP.
Revenue
We generate revenue in our subscription business segment primarily from subscription fees for our medical plan. Our medical plan automatically renews on a monthly basis, and members pay the subscription fee at the beginning of each subscription period, in most cases by authorizing 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 includes the writing of policies that provide different coverage and may have materially different terms and conditions than our subscription medical plan.
Cost of Revenue
Cost of revenue in each of our segments is comprised of claims expenses and other cost of revenue.
Claims expenses
Claims expenses include claims incurred, the cost of personnel administering the claims and providing member service relating to claims, and other operating expenses directly or indirectly related to claims administration. Claims incurred are the claims approved for payment plus an accrual for claims incurred that have not yet been submitted or approved for payment. This accrual is based on our historical experience, developments in the size and frequency of the average claim, and the cost of veterinary care, which also includes the cost of administering such claims.
Other cost of revenue
Other cost of revenue for the subscription business segment includes direct and indirect member service expenses, renewal fees, credit card transaction fees and premium tax expenses. Other cost of revenue for the other business segment includes the commissions the Company pays to unaffiliated general agents, costs to administer the programs in the other business segment and premium taxes on the policies in this segment.

17



For both our subscription business and our other business segments, we generally expect our cost of revenue to remain relatively constant as a percentage of revenue, although there may be some periodic variability due to a number of factors including the rate of claims occurrences during such periods. Claims expenses as a percentage of our subscription business revenue may increase over the long-term as part of our strategy to return more value to our members to further enhance our member experience, retention rates and lifetime value of a pet. We currently expect that, in the long-term, such increases generally would be offset by economies of scale in our other cost of revenue.
Gross Profit
Gross profit is total revenue less cost of revenue. We expect gross profit as a percentage of revenue in our subscription segment to remain relatively consistent in the long-term, although there has been and may be in the future some periodic variability due to a number of factors, including the rate of claims occurrences during such periods and in the timing and significance of our pricing adjustments. The timing of our implementation of various initiatives to improve the experience of our members also may affect gross profit in the short-term. Further, as the mix of subscription business and other business changes and as we add or modify relationships in our other business segment, this may impact our total gross profit as a percentage of revenue.
Operating Expenses
Our operating expenses are classified into three categories: sales and marketing, technology and development, and general and administrative. For each category, the largest component is personnel costs, which include salaries, employee benefit costs, bonuses and stock-based compensation expense.
Sales and Marketing
Sales and marketing expenses primarily consist of the cost to generate and convert a lead to an enrolled pet; print, online and promotional advertising costs; strategic partnership fees and personnel costs and related expenses. Sales and marketing expenses are driven primarily by investments to acquire new members. We plan to continue to invest in existing and new member acquisition channels and marketing initiatives to grow our business. Investments made in testing new member acquisition initiatives are generally more expensive than our traditional marketing channels and increase our average pet acquisition cost. We manage our sales and marketing expense on a per pet basis. As such, we expect sales and marketing expenses to fluctuate in absolute values and as a percentage of revenue based on how many new pets are enrolled in a period as well as the average pet acquisition cost. We base our sales and marketing spend on what we determine to be the appropriate ratio of lifetime value of a pet to average pet acquisition cost which is based on our desired return on investment.
Technology and Development
Technology and development expenses primarily consist of personnel costs and related expenses for our operations staff, which includes information technology development and infrastructure support, third-party services and depreciation of hardware and capitalized software and amortization of intangible assets. We expect technology and development expenses to decrease as a percentage of revenue as we continue to experience scale in our technology expenses.
General and Administrative
General and administrative expenses consist primarily of personnel costs and related expenses for our finance, actuarial, human resources, regulatory, legal, general management functions, as well as facilities and professional services. We expect general and administrative expenses to decrease as a percentage of revenue as we continue to experience scale in our general and administrative expenses.

18



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 our revenue for those periods. 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,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Consolidated Statement of Operations Data:
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Subscription business
$
56,493


$
44,629

 
$
159,363

 
$
125,934

Other business
6,625


3,730

 
16,759

 
10,956

Total revenue
63,118


48,359

 
176,122

 
136,890

Cost of revenue:
 
 
 
 
 
 
 
Subscription business(1)
45,215

 
36,432

 
129,052

 
102,793

Other business
6,096

 
3,427

 
15,757

 
10,027

Total cost of revenue
51,311

 
39,859

 
144,809

 
112,820

Gross profit:
 
 
 
 
 
 
 
Subscription business
11,278

 
8,197

 
30,311

 
23,141

Other business
529

 
303

 
1,002

 
929

Total gross profit
11,807


8,500

 
31,313

 
24,070

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing(1)
4,862

 
3,892

 
13,323

 
11,296

Technology and development(1)
2,471

 
2,339

 
7,196

 
6,790

General and administrative(1)
4,017

 
3,811

 
12,274

 
11,028

Total operating expenses
11,350

 
10,042

 
32,793

 
29,114

Operating income (loss)
457


(1,542
)
 
(1,480
)
 
(5,044
)
Interest expense
124

 
66

 
370

 
137

Other (income) expense, net
(99
)
 
16

 
(1,239
)
 
(39
)
Income (loss) before income taxes
432

 
(1,624
)
 
(611
)
 
(5,142
)
Income tax expense
26

 
13

 
54

 
31

Net income (loss)
$
406

 
$
(1,637
)
 
$
(665
)
 
$
(5,173
)

(1)
Includes stock-based compensation expense as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Cost of revenue
$
170

 
$
83

 
$
432

 
$
215

Sales and marketing
165

 
172

 
550

 
419

Technology and development
57

 
67

 
166

 
158

General and administrative
503

 
454

 
1,416

 
1,423

Total stock-based compensation expense
$
895

 
$
776

 
$
2,564

 
$
2,215



19



 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(as a % of revenue)
Revenue
100
 %
 
100
 %
 
100
 %
 
100
 %
Cost of revenue
81

 
82

 
82

 
82

Gross profit
19

 
18

 
18

 
18

Operating expenses:

 

 
 
 
 
Sales and marketing
8

 
8

 
8

 
8

Technology and development
4

 
5

 
4

 
5

General and administrative
6

 
8

 
7

 
8

Total operating expenses
18

 
21

 
19

 
21

Operating income (loss)
1

 
(3
)
 
(1
)
 
(3
)
Interest expense

 

 

 

Other (income) expense, net

 

 
(1
)
 

Income (loss) before income taxes
1

 
(3
)
 

 
(3
)
Income tax expense

 

 

 

Net income (loss)
1
 %
 
(3
)%
 
 %
 
(3
)%

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(as a % of subscription revenue)
Subscription business revenue
100
%
 
100
%
 
100
%
 
100
%
Subscription business cost of revenue
80

 
82

 
81

 
82

Subscription business gross profit
20
%
 
18
%
 
19
%
 
18
%


20



Comparison of Three and Nine Months Ended September 30, 2017 and 2016

Revenue
 
Three Months Ended September 30,
 
% Change
 
Nine Months Ended September 30,
 
% Change
 
2017
 
2016
 
 
2017
 
2016
 
 
(in thousands, except percentages, pet and per pet data)
 
 
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Subscription business
$
56,493

 
$
44,629

 
27
%
 
$
159,363

 
$
125,934

 
27
%
Other business
6,625

 
3,730

 
78

 
16,759

 
10,956

 
53

Total revenue
$
63,118

 
$
48,359

 
31

 
$
176,122

 
$
136,890

 
29

 
 
 
 
 
 
 
 
 
 
 
 
Percentage of Revenue by Segment:
 
 
 
 


 
 
 
 
 
 
Subscription business
90
%
 
92
%
 


 
90
%
 
92
%
 
 
Other business
10

 
8

 


 
10

 
8

 
 
Total revenue
100
%
 
100
%
 


 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total subscription pets enrolled (at period end)
359,102

 
312,282

 
15

 
359,102

 
312,282

 
15

Total pets enrolled (at period end)
404,069

 
334,070

 
21

 
404,069

 
334,070

 
21

Monthly average revenue per pet
$
52.95

 
$
48.37

 
9

 
$
51.67

 
$
47.33

 
9

Three months ended September 30, 2017 compared to three months ended September 30, 2016. Total revenue increased by $14.8 million to $63.1 million for the three months ended September 30, 2017, or 31%. Revenue from our subscription business segment increased by $11.9 million to $56.5 million for the three months ended September 30, 2017, or 27%. This increase in subscription business revenue was primarily due to a 15% increase in total subscription pets enrolled as of September 30, 2017 compared to September 30, 2016, and increased average revenue per pet of 9% for the same period. Increases in pricing were due to increased cost of veterinary care and more accurately pricing to our cost-plus margin structure by subcategory. Revenue from our other business segment increased $2.9 million to $6.6 million for the three months ended September 30, 2017, or 78%, due to an increase in enrolled pets in this segment.
Nine months ended September 30, 2017 compared to nine months ended September 30, 2016. Total revenue increased by $39.2 million to $176.1 million for the nine months ended September 30, 2017, or 29%. Revenue from our subscription business segment increased by $33.4 million to $159.4 million for the nine months ended September 30, 2017, or 27%. This increase in subscription business revenue was primarily due to a 15% increase in total subscription pets enrolled as of September 30, 2017 compared to September 30, 2016, and increased average revenue per pet of 9% for the same period. Increases in pricing were due to increased cost of veterinary care and more accurately pricing to our cost-plus margin structure by subcategory. Revenue from our other business segment increased $5.8 million to $16.8 million for the nine months ended September 30, 2017, or 53%, due to an increase in enrolled pets in this segment.

21



Cost of Revenue
 
Three Months Ended September 30,
 
% Change
 
Nine Months Ended September 30,
 
% Change
 
2017
 
2016
 
 
2017
 
2016
 
 
(in thousands, except percentages, pet and per pet data)
 
 
Cost of Revenue:
 
 
 
 
 
 
 
 
 
 
 
Subscription business:
 
 
 
 
 
 
 
 
 
 
 
Claims expenses
$
39,761

 
$
32,088

 
24
%
 
$
113,748

 
$
90,709

 
25
%
Other cost of revenue
5,454

 
4,344

 
26

 
15,304

 
12,084

 
27

Total cost of revenue
$
45,215

 
$
36,432

 
24

 
$
129,052

 
$
102,793

 
26

Gross profit
$
11,278

 
$
8,197

 
38

 
$
30,311

 
$
23,141

 
31

Other business:
 
 
 
 


 
 
 
 
 
 
Claims expenses
3,692

 
2,165

 
71

 
9,901

 
6,614

 
50

Other cost of revenue
2,404

 
1,262

 
90

 
5,856

 
3,413

 
72

Total cost of revenue
$
6,096

 
$
3,427

 
78

 
$
15,757

 
$
10,027

 
57

Gross profit
$
529

 
$
303

 
75

 
$
1,002

 
$
929

 
8

 
 
 
 
 
 
 
 
 
 
 
 
Percentage of Revenue by Segment:
 
 
 
 
 
 
 
 
 
 
 
Subscription business:
 
 
 
 
 
 
 
 
 
 
 
Claims expenses
70
%
 
72
%
 
 
 
71
%
 
72
%
 
 
Other cost of revenue
10

 
10

 
 
 
10

 
10

 
 
Total cost of revenue
80

 
82

 
 
 
81

 
82

 
 
Gross profit
20

 
18

 
 
 
19

 
18

 
 
Other business:
 
 
 
 
 
 
 
 
 
 
 
Claims expenses
56

 
58

 
 
 
59

 
60

 
 
Other cost of revenue
36

 
34

 
 
 
35

 
31

 
 
Total cost of revenue
92

 
92

 
 
 
94

 
92

 
 
Gross profit
8

 
8

 
 
 
6

 
8

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total subscription pets enrolled (at period end)
359,102

 
312,282

 
15

 
359,102

 
312,282

 
15

Total pets enrolled (at period end)
404,069

 
334,070

 
21

 
404,069

 
334,070

 
21

Monthly average revenue per pet
$
52.95

 
$
48.37

 
9

 
$
51.67

 
$
47.33

 
9

Three months ended September 30, 2017 compared to three months ended September 30, 2016. Cost of revenue for our subscription business segment was $45.2 million, or 80% of revenue, for the three months ended September 30, 2017, compared to $36.4 million, or 82% of revenue, for the three months ended September 30, 2016. This $8.8 million increase in subscription total cost of revenue was primarily the result of a 15% increase in total subscription pets enrolled and an increase in the cost of veterinary care, which increased subscription claims expense by 24% in total. As a percentage of revenue, subscription claims expenses decreased to 70% for the three months ended September 30, 2017 from 72% for the three months ended September 30, 2016, due to the increase in monthly average revenue per pet. Total cost of revenue for our other business segment increased $2.7 million to $6.1 million for the three months ended September 30, 2017 due to an increase in enrolled pets in this segment.