Edgar Filing: TRUPANION INC.

10-Q Q2 2015

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 June 30, 2015

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)

907 NW Ballard Way

Seattle, Washington 98107

(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, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.



Large accelerated filer	o		Accelerated filer	o
Non-accelerated filer	x	(Do not check if smaller reporting company)	Smaller reporting company	o

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 July 31, 2015 there were approximately 28,269,880 shares of the registrant’s common stock outstanding.

TRUPANION, INC.

TABLE OF CONTENTS



		Page

PART I-FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)	1
	Consolidated Statements of Operations for the three and six months ended June 30, 2015 and 2014	1
	Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2015 and 2014	2
	Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014	3
	Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014	4
	Notes to the Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
Item 4.	Controls and Procedures	31
PART II-OTHER INFORMATION
Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	57
Item 6.	Exhibits	59
	Signatures	58
	Exhibit Index	59

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), SEC 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 ("U.S.") 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 for share and per share data) (unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
Revenue	$	35,587		$	28,090		$	68,897		$	53,730
Cost of revenue:
Claims expenses	25,487			18,977			48,838			36,012
Other cost of revenue	4,314			3,963			8,691			7,812
Gross profit	5,786			5,150			11,368			9,906
Operating expenses:
Sales and marketing	3,533			2,810			7,184			5,456
Technology and development	2,879			2,553			5,677			4,753
General and administrative	3,996			3,292			7,693			6,078
Total operating expenses	10,408			8,655			20,554			16,287
Operating loss	(4,622		)	(3,505		)	(9,186		)	(6,381		)
Interest expense	40			726			285			1,462
Other (income) expense, net	(15		)	(759		)	4			528
Loss before income taxes	(4,647		)	(3,472		)	(9,475		)	(8,371		)
Income tax (benefit) expense	(22		)	7			86			21
Net loss	$	(4,625	)	$	(3,479	)	$	(9,561	)	$	(8,392	)

Net loss per share:
Basic and diluted	$	(0.17	)	$	(2.25	)	$	(0.35	)	$	(5.47	)
Weighted-average shares used to compute net loss per share:
Basic and diluted	27,597,721			1,543,134			27,468,231			1,533,668

Trupanion, Inc. Consolidated Statements of Comprehensive Loss (in thousands) (unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
Net loss	$	(4,625	)	$	(3,479	)	$	(9,561	)	$	(8,392	)
Other comprehensive (loss) income:
Foreign currency translation adjustments	55			(27		)	(74		)	24
Change in unrealized losses on available-for-sale securities	(33		)	60			(41		)	95
Other comprehensive income (loss), net of taxes	22			33			(115		)	119
Comprehensive loss	$	(4,603	)	$	(3,446	)	$	(9,676	)	$	(8,273	)

Trupanion, Inc. Consolidated Balance Sheets (in thousands, except for share data)

	June 30, 2015			December 31, 2014
Assets	(unaudited)
Current assets:
Cash and cash equivalents	$	26,157		$	53,098
Short-term investments	21,547			22,371
Accounts and other receivables	8,778			7,887
Prepaid expenses and other assets	1,677			1,299
Total current assets	58,159			84,655
Long-term investments, at fair value	2,520			942
Property and equipment, net	9,131			7,862
Intangible assets, net	4,815			4,847
Other long term assets	23			—
Total assets	$	74,648		$	98,306
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	1,218		$	1,962
Accrued liabilities	3,720			4,607
Claims reserve	5,839			5,107
Deferred revenue	10,115			9,345
Other payables	481			1,523
Total current liabilities	21,373			22,544
Long-term debt	—			14,900
Deferred tax liabilities	1,495			1,495
Other liabilities	112			92
Total liabilities	22,980			39,031
Stockholders’ equity:
Common stock, $0.00001 par value per share, 200,000,000 shares authorized at June 30, 2015 and December 31, 2014, 28,871,964 and 28,250,985 issued and outstanding at June 30, 2015; 28,451,920 and 27,830,941 shares issued and outstanding at December 31, 2014.	—			—
Preferred stock: $0.00001 par value per share, 10,000,000 authorized at June 30, 2015 and December 31, 2014, and 0 issued and outstanding at June 30, 2015 and December 31, 2014.	—			—
Additional paid-in capital	121,114			119,045
Accumulated other comprehensive (loss) income	(104		)	11
Accumulated deficit	(66,741		)	(57,180		)
Treasury stock, at cost: 620,979 shares at June 30, 2015 and December 31, 2014.	(2,601		)	(2,601		)
Total stockholders’ equity	51,668			59,275
Total liabilities and stockholders’ equity	$	74,648		$	98,306

Trupanion, Inc. Consolidated Statements of Cash Flows (in thousands) (unaudited)


	Six Months Ended June 30,
	2015			2014
Operating activities
Net loss	$	(9,561	)	$	(8,392	)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization	1,129			729
Amortization of debt discount and prepaid loan fees	—			470
Warrant expense	—			480
Stock-based compensation expense	1,600			1,193
Other, net	(113		)	52
Changes in operating assets and liabilities:
Accounts receivable	(923		)	(320		)
Prepaid expenses and other current assets	(380		)	(121		)
Accounts payable	(552		)	75
Accrued liabilities	(617		)	(428		)
Claims reserve	714			(1,219		)
Deferred revenue	749			303
Other payables	(942		)	743
Net cash used in operating activities	(8,896		)	(6,435		)
Investing activities
Purchases of investment securities	(11,066		)	(16,266		)
Maturities of investment securities	10,266			18,277
Purchases of property and equipment	(2,644		)	(2,268		)
Net cash used in investing activities	(3,444		)	(257		)
Financing activities
Release of restricted cash	—			300
Advance on term loan	—			2,000
Deferred financing costs	—			(1,091		)
Proceeds from exercise of stock options	801			46
Payment on line of credit	(14,900		)	(300		)
Tax withholding on restricted stock	(384		)	—
Net cash (used in) provided by financing activities	(14,483		)	955
Effect of foreign exchange rates on cash, net	(118		)	86
Net change in cash and cash equivalents	(26,941		)	(5,651		)
Cash and cash equivalents at beginning of period	53,098			14,939
Cash and cash equivalents at end of period	$	26,157		$	9,288
Supplemental disclosures
Income taxes paid	117			9
Interest paid	259			457
Noncash investing and financing activities:
Increase in payables for property and equipment	349			518
Increase in payables for deferred financing costs	—			1,487
Cashless exercise of preferred stock warrants	—			999

Trupanion, Inc.

Notes to the Consolidated Financial Statements (unaudited)

1. Nature of Operations and Summary of Significant Accounting Policies

Description of Business

Trupanion, Inc. (collectively with its wholly-owned subsidiaries, the Company) is a direct-to-consumer monthly subscription service provider of a medical plan for cats and dogs throughout the United States, Canada and Puerto Rico.

Basis of Presentation

The consolidated balance sheet data as of December 31, 2014 was derived from audited consolidated financial statements. The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for unaudited consolidated financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. These unaudited consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes for the year ended December 31, 2014 included in the Company’s Annual Report on Form 10-K, filed with the U.S Securities and Exchange Commission on February 24, 2015. The accompanying unaudited consolidated financial statements reflect all adjustments consisting of normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the Company’s financial position and results of its operations, as of and for the periods presented. Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015, or for any other 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. In addition, amounts in note 8 related to segments have been recast to reflect a change in the composition of the Company’s segments as described in note 8.

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 reported amounts of assets and liabilities and disclosure of contingencies and the reported amounts of revenue and expenses. Significant items subject to such estimates and assumptions include the valuation of deferred tax assets, stock-based compensation, claims reserve and useful lives of software developed for internal use. Actual results could differ from the estimates used in preparing the consolidated financial statements.

Advertising

Advertising costs are expensed as incurred, with the exception of television advertisements, which are expensed the first time advertisement is aired.

Accumulated Other Comprehensive Loss

There were no reclassifications out of accumulated other comprehensive loss during the three and six months ended June 30, 2015 and 2014.

Insurance Operations

Effective January 1, 2015, the Company formed a segregated account in Bermuda as part of Wyndham Insurance Company (SAC) Limited (WICL), and entered into a revised fronting and reinsurance arrangement with Omega General Insurance Company (Omega) to include its newly formed segregated account. The Company maintains all risk with the business written in Canada and consolidates the entity in its financial statements. Contractual requirements restrict dividends from this entity until after 2016, at which time dividends will be allowed subject to the Segregated Accounts Company Act of 2000, which allows for dividends only to the extent that the entity 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.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standard Update (ASU) amending revenue recognition guidance and requiring more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Insurance contracts are excluded from the scope of this new guidance. The guidance is effective for annual and interim reporting periods beginning after December 15, 2017, with early adoption prohibited, and must be applied retrospectively or modified retrospectively. The Company does not believe this ASU will have a material impact on its consolidated financial statements.

In May 2015, the FASB issued an ASU amending short-term insurance contracts disclosures and requiring more detailed disclosures to enable users of financial statements to understand information relating to liabilities for unpaid claims and claims adjustment expenses. Additionally, the amendments will also require insurance entities to disclose information about significant changes in methodologies and assumptions used to calculate these liabilities. This guidance is effective for annual reporting periods beginning after December 15, 2015 and interim periods beginning after December 15, 2016. Early adoption of this guidance is permitted, and must be applied retrospectively by providing comparative disclosures for each period presented. We plan to adopt this guidance in 2016.

2. Net Loss per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of shares of common stock outstanding for the period. Excluded from the weighted-average number of shares outstanding are shares that have been issued and are subject to future vesting and unvested restricted stock. Diluted net loss per share is calculated by dividing the net loss by the weighted-average number of common stock equivalents outstanding for the period determined using the treasury-stock method. Potentially dilutive common stock equivalents are comprised of convertible preferred stock, warrants for the purchase of convertible preferred stock and common stock, exchangeable shares, unvested restricted stock, restricted stock units, and stock options. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company’s net loss position.

The following potentially dilutive equity securities are not included in the diluted net loss per common share calculation because they would have had an antidilutive effect:



	As of June 30,
	2015	2014
Stock options	4,632,036	4,959,826
Restricted stock awards and units	592,553	706,514
Warrants	869,999	784,111
Series A convertible preferred stock	—	7,553,239
Series B convertible preferred stock	—	3,546,384
Series C convertible preferred stock	—	3,845,322
Exchangeable shares	—	2,247,130

Convertible preferred stock is presented on an as converted basis to reflect the applicable conversion ratio.

3. Investment Securities

The amortized cost, gross unrealized holding 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 June 30, 2015 and December 31, 2014 (in thousands):



	Amortized Cost		Gross Unrealized Holding Losses			Fair Value
As of June 30, 2015
Available-for-sale:
Foreign deposits	$	1,619	$	—		$	1,619
Municipal bond	$	1,000	$	(99	)	$	901
	$	2,619	$	(99	)	$	2,520
Short-term investments:
U.S. Treasury securities	$	5,784	$	(1	)	$	5,783
Certificates of deposit	800		—			800
U.S. government funds	14,963		—			14,963
	$	21,547	$	(1	)	$	21,546

	Amortized Cost		Gross Unrealized Holding Losses			Fair Value
As of December 31, 2014
Available-for-sale:
Municipal bond	$	1,000	$	(58	)	$	942
	$	1,000	$	(58	)	$	942
Short-term investments:
U.S. Treasury securities	$	5,677	$	—		$	5,677
Certificates of deposit	800		—			$	800
U.S. government funds	15,894		—			$	15,894
	$	22,371	$	—		$	22,371

Maturities of debt securities classified as available-for-sale were as follows (in thousands):



	June 30, 2015
	Amortized Cost		Fair Value
Available-for-sale:
Due under one year	$	—	$	—
Due after one year through five years	1,619		1,619
Due after five years through ten years	1,000		901
Due after ten years	—		—
	$	2,619	$	2,520

The Company had one investment with an unrealized loss of $0.1 million and a fair value of $0.9 million at June 30, 2015 and December 31, 2014, respectively. The debt security has been in the unrealized loss position for more than 12 months. The Company has assessed the bond for credit impairment and has determined that there is no intent to sell this bond and it is likely that it will hold the investment for a period of time sufficient to allow for a recovery. Furthermore, future payments on this bond are insured by a financial guarantee insurer. Therefore, the Company believes that the unrealized loss on this bond constitutes a temporary impairment.

4. Fair Value

The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible.

When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:


•	Level 1 inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.


•	Level 2 inputs: Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.


•	Level 3 inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.

The following table presents the placement in the fair value hierarchy of assets and liabilities that are measured at fair value on a recurring basis (in thousands):



	As of June 30, 2015
	Fair Value		Level 1		Level 2		Level 3
Assets
Foreign deposits	$	1,619	$	1,619	$	—	$	—
Municipal bond	901		—		901		—
Money market funds	16,752		16,752		—		—
Total	$	19,272	$	18,371	$	901	$	—

	As of December 31, 2014
	Fair Value		Level 1		Level 2		Level 3
Assets
Municipal bond	$	942	$	—	$	942	$	—
Money market funds	44,575		44,575		—		—
Total	$	45,517	$	44,575	$	942	$	—

The Company estimates fair value for its 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 December 31, 2014.

The Company’s accounting policy is to recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer. There were no transfers between levels for the three and six months ended June 30, 2015 and 2014.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

•

Investment securities: Debt securities classified as available-for-sale are measured using quoted market prices when quoted market prices are available. If quoted market prices in active markets for identical assets are not available to determine fair value, then the Company uses quoted prices of similar instruments and other significant inputs derived from observable market data obtained from third-party data providers. Held-to-maturity securities are carried at amortized cost and the fair value is disclosed in Note 3. Fair value is determined in the same manner as available-for-sale securities and is considered a Level 2 measurement.

5. Debt

The Company has a revolving line of credit with a bank, which is secured by any and all interest the Company has in assets that are not otherwise restricted. The revolving line of credit bears a variable interest rate equal to the greater of 5.0% or 1.5% plus the prime rate. Interest expense is due monthly on the outstanding principal amount with all amounts outstanding under the revolving line of credit due upon maturity in July 2016. The credit agreement requires the Company to comply with various financial and non-financial covenants. This facility also has a compensating balance requirement of $0.5 million.

Borrowings on the revolving line of credit are limited to the lesser of $20.0 million in 2015 and 2014, and the total amount of cash and securities held by American Pet Insurance Company (APIC), less up to $0.5 million for obligations the Company may have outstanding for other ancillary services.

During the first quarter of 2015, we repaid our borrowings under this facility and, as of June 30, 2015, we had no outstanding amounts under this facility.

6. Commitments and Contingencies

The Company has entered into strategic marketing and service provider agreements, as well as other agreements with various parties. As of the June 30, 2015, these agreements resulted in an increase in future commitments of $0.8 million in 2015, $1.8 million in 2016 and $0.7 million in 2017.

The Company completed a voluntary self-disclosure with the Canada Revenue Agency related to goods and services tax (GST) and harmonized sales tax (HST) owed for 2007 through 2013. During the six months ended June 30, 2015, the Company received the final assessment of GST and HST owed and paid the full amount of $0.8 million to the Canada Revenue Agency.

The Company received an inquiry from the Washington State Office of the Insurance Commissioner (OIC) in December 2012 concerning whether subsidiaries of the Company were properly licensed, and whether certain of its employees were properly licensed, under Washington law. A regulatory examination took place during the third and fourth quarters of 2014. As of June 30, 2015 and December 31, 2014, the Company had accrued liabilities of $0.3 million and $0.2 million, respectively, for this matter. Adverse outcomes beyond recorded amounts are reasonably possible. At this stage in the matter, however, the Company is unable to estimate a possible loss or range of possible loss beyond amounts accrued.

The outcomes of the Company’s legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to our operating results and cash flows for a particular period. The Company makes a provision for a liability relating to legal matters when it is both probable that a liability beyond previously accrued amounts has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter.

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)
December 31, 2014	5,112,556		$	3.19	$	21,116
Granted	152,624		7.79
Exercised	(454,613	)	1.76		2,814
Forfeited	(178,531	)	8.96
June 30, 2015	4,632,036		3.26		23,831

Vested and exercisable at June 30, 2015	3,455,067		$	2.06	$	21,521

As of June 30, 2015, the stock options outstanding had a remaining contractual life of 6.32 years.

Stock-based compensation expense includes stock options and restricted stock granted to employees and non-employees and has been reported in the Company’s statements of operations in claims expenses, other cost of revenue, sales and marketing, technology and development, and general and administrative expenses depending on the function performed by the employee or non-employee. The Company measures compensation expense on a straight-line basis except for restricted stock with a performance condition which is measured on a graded vesting schedule. The remaining 584,385 shares of unvested restricted stock measured on a graded vesting schedule are expected to vest over the remaining service term of approximately 4.25 years.

As of June 30, 2015, the Company had unrecognized stock-based compensation of $5.6 million related to stock options and restricted stock held by employees and non-employees, which is expected to vest over a weighted-average period of approximately 2.30 years. As of June 30, 2015, the Company had 1,176,969 unvested stock options and 592,553 restricted stock awards that are expected to vest. No net tax benefits related to the stock-based compensation costs have been recognized since the Company’s inception. The expense recognized in each category is provided in the table below:



	Three Months Ended June 30,				Six Months Ended June 30,
	2015		2014		2015		2014
	(in thousands)
Claims expenses	$	49	$	51	$	102	$	108
Other cost of revenue	9		13		25		37
Sales and marketing	110		144		240		293
Technology and development	93		98		214		196
General and administrative	636		320		1,019		559
Total stock-based compensation	$	897	$	626	$	1,600	$	1,193

8. Segments

The Company operates in 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 which is not directly marketed to consumers. Prior to January 1, 2015, certain enrollments not marketed directly to consumers were included in the subscription business segment as they were not segregated in reporting used by the chief operating decision maker. As of January 1, 2015, the Company began reporting these pets in its other business segment due to the characteristics of this business being similar to other arrangements within the other business segment. In addition, the chief operating decision maker began using information related to the subscription business segment excluding these pets in order to evaluate the Company's business and operations and make decisions. As such, these pets have been considered a part of the other business segment after January 1, 2015. Prior period segment information presented below has been recast to reflect this change.

The chief operating decision maker uses two measures to evaluate segment performance: revenue and gross profit. Corporate operating expenses, 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 June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
Revenue:
Subscription business	$	32,208		$	24,912		$	62,264		$	47,773
Other business	3,379			3,178			6,633			5,957
	35,587			28,090			68,897			53,730
Claims expenses:
Subscription business	23,396			17,585			44,898			33,482
Other business	2,091			1,392			3,940			2,530
	25,487			18,977			48,838			36,012
Other cost of revenue:
Subscription business	3,265			2,688			6,529			5,179
Other business	1,049			1,275			2,162			2,633
	4,314			3,963			8,691			7,812
Gross profit:
Subscription business	5,547			4,639			10,837			9,112
Other business	239			511			531			794
	5,786			5,150			11,368			9,906
Sales and marketing	3,533			2,810			7,184			5,456
Technology and development	2,879			2,553			5,677			4,753
General and administrative	3,996			3,292			7,693			6,078
Operating loss	$	(4,622	)	$	(3,505	)	$	(9,186	)	$	(6,381	)

The following table presents the Company’s revenue by geographic region of the member (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2015		2014		2015		2014
United States	$	27,767	$	20,925	$	53,598	$	39,822
Canada	7,820		7,165		15,299		13,908
Total revenue	$	35,587	$	28,090	$	68,897	$	53,730

Substantially all of the Company’s long-lived assets were located in the United States as of June 30, 2015.

9. Subsequent Events

On July 24, 2015 the Company granted employees options to purchase a total of 426,549 shares of common stock exercisable at a price of $7.78 per share, vesting over four years.

Item 2. - Management’s Discussion and Analysis of Financial Conditions and Results of Operations

Overview

We are a direct-to-consumer monthly subscription service providing a medical 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 available for their pets, priced specifically for each pet’s unique characteristics. Our growing and loyal member base provides us with highly predictable and recurring revenue. We operate our business with a focus on maximizing the lifetime value of each pet while sustaining a favorable ratio of lifetime value relative to acquisition cost.

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 policies that are not marketed directly to consumers.

We generate leads for our subscription business through both third-party referrals and online member 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 independent contractors who are paid fees based on activity in their regions, which we refer to as our Territory Partners. 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. Our online member acquisition channels serve as important resources for pet owner education and drive new member leads and conversion. We also receive a significant number of new leads from existing members adding pets and referring their friends and family members. We constantly 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 $53.7 million for the six months ended June 30, 2014 to $68.9 million for the six months ended June 30, 2015, representing 28% 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 six months ended June 30, 2015 and 2014, we had a net loss of $9.6 million and $8.4 million respectively. As of June 30, 2015, our accumulated deficit was $66.7 million.

Key Financial and Operating Metrics

We believe that one of the key operating drivers for any online subscription business is the amount of sales and marketing expenses incurred to drive new member acquisition, which typically is evaluated in relation to the lifetime value of the member’s pet. In order to assess this metric, we regularly review a number of financial and operating metrics, including per pet unit economics, to evaluate our subscription business, determine the allocation of resources and make decisions regarding business strategy.

The following tables set forth our key financial and operating metrics for our subscription business for the periods ended June 30, 2015 and 2014 and for each of the last eight fiscal quarters. The prior period metrics have been recast to reflect the movement of pets from the subscription business segment to the other business segment in 2015. For more information on this change see "Basis of Presentation."



	Six Months Ended June 30,
	2015			2014
Total pets enrolled (at period end)	259,948			207,969
Total subscription pets enrolled (at period end)	241,808			192,338
Monthly adjusted revenue per pet	$	44.73		$	43.34
Lifetime value of a pet (LVP)	$	570		$	602
Average pet acquisition cost (PAC)	$	133		$	113
Average monthly retention	98.67		%	98.65		%
Adjusted EBITDA (in thousands)	$	(6,498	)	$	(4,538	)



	Three Months Ended
	Jun. 30, 2015			Mar. 31, 2015			Dec. 31, 2014			Sept. 30, 2014			Jun. 30, 2014			Mar. 31, 2014			Dec. 31, 2013			Sept. 30, 2013
Total pets enrolled (at period end)	259,948			246,106			232,450			221,479			207,969			194,902			182,497			172,184
Total subscription pets enrolled (at period end)	241,808			228,409			215,491			205,194			192,338			179,819			168,405			159,080
Monthly adjusted revenue per pet	$	45.10		$	44.34		$	44.79		$	44.88		$	43.60		$	43.07		$	43.06		$	42.55
Lifetime value of a pet (LVP)	$	570		$	567		$	591		$	580		$	602		$	612		$	613		$	619
Average pet acquisition cost (PAC)	$	133		$	134		$	145		$	115		$	114		$	113		$	106		$	81
Average monthly retention	98.67		%	98.66		%	98.69		%	98.67		%	98.65		%	98.65		%	98.65		%	98.64		%
Adjusted EBITDA (in thousands)	$	(3,165	)	$	(3,333	)	$	(2,903	)	$	(2,908	)	$	(2,459	)	$	(2,079	)	$	(1,780	)	$	(378	)

Total pets enrolled. Total pets enrolled reflects the number of pets subscribed to either our plan or one of the plans 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 our core plan 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 adjusted revenue per pet. Monthly adjusted revenue per pet is calculated as adjusted revenue divided by the total number of subscription pet months in the period. Adjusted revenue, a non-GAAP financial measure, is calculated as subscription business revenue, excluding sign-up fee revenue and the change in deferred revenue. We exclude sign-up fee revenue since it is collected at the time a new pet is enrolled and is used to partially offset initial setup costs, which are included in sales and marketing expenses. We exclude changes in deferred revenue in order to present monthly adjusted revenue per pet in a consistent manner across periods. Total subscription pet months in a period represents the sum of all pets enrolled for each month during the period. We monitor monthly adjusted revenue per pet because it is an indicator of the per unit economics of our business.

Lifetime value of a pet. Lifetime value of a pet (LVP) is calculated in a reporting period as the average monthly contribution margin per pet over the 12 months prior to the period end date, multiplied by the implied average subscriber life in months. The average monthly contribution margin per pet is calculated by dividing gross profit for our subscription business for the period, excluding sign-up fee revenue, the change in deferred revenue and stock based compensation expense recorded in cost of revenue by the number of subscription pet months in the 12-month period. 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 contribution margin 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.

Average pet acquisition cost. Average pet acquisition cost (PAC) is calculated as acquisition cost divided by the total number of new subscription pets enrolled in that period. Acquisition cost, a non-GAAP financial measure, is calculated in a reporting period as sales and marketing expenses, excluding stock-based compensation, offset by sign-up fee revenue. 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 in acquiring new members and measure effectiveness using the ratio of our lifetime value of a pet to average pet acquisition cost.

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 June 30, 2015 is an average of each month’s retention from July 1, 2014 through June 30, 2015. We calculate monthly retention as the number of subscription pets that remain after subtracting all subscription pets that cancel during a month, including subscription pets that enroll and cancel within that month, divided by the total subscription 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 and manage our business.

Adjusted EBITDA. Adjusted EBITDA is a non-GAAP financial measure that we define as net loss excluding stock-based compensation expense, depreciation and amortization expense, interest income, interest expense, change in fair value of warrant liabilities and income tax expense (benefit). For more information about adjusted EBITDA and a reconciliation of net loss to adjusted EBITDA, see Non-GAAP Financial Measures below.

Non-GAAP Financial Measures

We believe that using adjusted revenue, contribution margin and 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 adjusted revenue as revenue from our subscription business segment excluding sign-up fee revenue and the change in deferred revenue between periods. We define contribution margin as 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. We define acquisition cost as sales and marketing expenses, excluding stock-based compensation expense, net of sign-up fee revenue.

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. Further, stock-based compensation expense and other items used in the calculation of adjusted EBITDA have been and will continue to be for the foreseeable future significant recurring expenses in our business. 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 contribution margin, acquisition cost and adjusted EBITDA that exclude stock-based compensation expense and, in the case of adjusted EBITDA, the change in fair value of warrant liabilities allows for more meaningful comparisons between our operating results from period to period. We exclude sign-up fee revenue from the calculation of both adjusted revenue and contribution margin 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. For this reason, we also net sign-up fees with sales and marketing expenses in our calculation of acquisition cost. We exclude changes in deferred revenue from the calculation of both adjusted revenue and contribution margin in order to eliminate fluctuations caused by the timing of pet enrollment during the last month of any particular period in which such measures are being presented or utilized. We exclude the change in fair value of warrant liabilities from our calculation of adjusted EBITDA in order to eliminate fluctuations caused by changes in our stock price. We believe this allows us to calculate and present adjusted revenue, contribution margin and acquisition cost and the related financial measures we derive from them, as well as adjusted EBITDA, 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.

The following tables reflect the reconciliation of adjusted revenue to revenue:



	Six Months Ended June 30,
	2015			2014

Revenue	$	68,897		$	53,730
Excluding:
Other business revenue	(6,633		)	(5,957		)
Change in deferred revenue	649			346
Sign-up fee revenue	(935		)	(784		)
Adjusted revenue	$	61,978		$	47,335



	Three Months Ended
	Jun. 30, 2015			Mar. 31, 2015			Dec. 31, 2014			Sept. 30, 2014			Jun. 30, 2014			Mar. 31, 2014			Dec. 31, 2013			Sept. 30, 2013
	(in thousands)
Revenue	$	35,587		$	33,310		$	31,868		$	30,312		$	28,090		$	25,640		$	24,011		$	22,134
Excluding:
Other business revenue	(3,379		)	(3,254		)	(3,251		)	(3,200		)	(3,178		)	(2,779		)	(2,736		)	(2,256		)
Change in deferred revenue	321			328			247			385			84			262			452			314
Sign-up fee revenue	(451		)	(484		)	(363		)	(425		)	(407		)	(377		)	(345		)	(386		)
Adjusted revenue	$	32,078		$	29,900		$	28,501		$	27,072		$	24,589		$	22,746		$	21,382		$	19,806

The following table reflects the reconciliation of contribution margin to gross profit:



	Twelve Months Ended
	Jun. 30, 2015			Mar. 31, 2015			Dec. 31, 2014			Sept. 30, 2014			Jun. 30, 2014			Mar. 31, 2014			Dec. 31, 2013			Sept. 30, 2013
	(in thousands)
Gross profit	$	21,337		$	20,701		$	19,874		$	18,439		$	18,113		$	16,792		$	15,644		$	14,788
Excluding:
Stock-based compensation expense	296			302			315			309			287			270			230			171
Other business segment gross profit	(1,278		)	(1,549		)	(1,539		)	(1,468		)	(1,314		)	(967		)	(768		)	(572		)
Change in deferred revenue	1,281			1,044			977			1,183			1,111			1,246			1,107			874
Sign-up fee revenue	(1,723		)	(1,679		)	(1,572		)	(1,554		)	(1,514		)	(1,464		)	(1,418		)	(1,356		)
Contribution margin	$	19,913		$	18,819		$	18,055		$	16,909		$	16,683		$	15,877		$	14,795		$	13,905

The following tables reflect the reconciliation of acquisition cost to sales and marketing expense:



		Six Months Ended June 30,
		2015			2014
	(in thousands)
Sales and marketing expense		$	7,184		$	5,456
Excluding:
Stock-based compensation expense		(240		)	(293		)
Other business segment sales and marketing expense		(56		)	(72		)
Net of:
Sign-up fee revenue		(935		)	(784		)
Acquisition cost		$	5,953		$	4,307



	Three Months Ended
	Jun. 30, 2015			Mar. 31, 2015			Dec. 31, 2014			Sept. 30, 2014			Jun. 30, 2014			Mar. 31, 2014			Dec. 31, 2013			Sept. 30, 2013
	(in thousands)
Sales and marketing expense	$	3,533		$	3,651		$	3,218		$	2,934		$	2,810		$	2,646		$	2,238		$	2,013
Excluding:
Stock-based compensation expense	(110		)	(130		)	(147		)	(115		)	(144		)	(149		)	(185		)	(147		)
Other business segment sales and marketing expense	(30		)	(26		)	(30		)	(22		)	(28		)	(44		)	(6		)	(3		)
Net of:
Sign-up fee revenue	(451		)	(484		)	(363		)	(425		)	(407		)	(377		)	(345		)	(386		)
Acquisition cost	$	2,942		$	3,011		$	2,678		$	2,372		$	2,231		$	2,076		$	1,702		$	1,477

The following tables reflect the reconciliation of adjusted EBITDA to net loss:



		Six Months Ended June 30,
		2015			2014
	(in thousands)
Net loss		$	(9,561	)	$	(8,392	)
Excluding:
Stock-based compensation expense		1,600			1,193
Depreciation and amortization expense		1,129			729
Interest income		(37		)	(36		)
Interest expense		285			1,468
Change in fair value of warrant liabilities		—			479
Income tax expense		86			21
Adjusted EBITDA		$	(6,498	)	$	(4,538	)



	Three Months Ended
	Jun. 30, 2015			Mar. 31, 2015			Dec. 31, 2014			Sept. 30, 2014			Jun. 30, 2014			Mar. 31, 2014			Dec. 31, 2013			Sept. 30, 2013
	(in thousands)
Net loss	$	(4,625	)	$	(4,936	)	$	(4,276	)	$	(8,509	)	$	(3,479	)	$	(4,913	)	$	(3,203	)	$	(1,222	)
Excluding:
Stock-based compensation expense	897			703			890			2,001			626			567			574			478
Depreciation and amortization expense	563			566			441			505			419			310			229			243
Interest income	(18		)	(19		)	(18		)	(20		)	(18		)	(18		)	(13		)	(32		)
Interest expense	40			245			103			5,155			726			742			225			154
Change in fair value of warrant liabilities	—			—			—			(2,054		)	(740		)	1,219			414			3
Income tax (benefit) expense	(22		)	108			(43		)	14			7			14			(6		)	(2		)
Adjusted EBITDA	$	(3,165	)	$	(3,333	)	$	(2,903	)	$	(2,908	)	$	(2,459	)	$	(2,079	)	$	(1,780	)	$	(378	)

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 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. For example, veterinary trade show costs have traditionally increased our average pet acquisition costs in the first quarter of each year and the timing of our Territory Partner conference can also increase our average pet acquisition cost in a given period. We also may periodically test new member acquisition channels and marketing initiatives, such as television advertising, each of which impacts our average pet acquisition cost. We plan to expand the number of Territory Partners and their associates, which is likely to increase our average pet acquisition cost. We continually assess our sales and marketing activities by monitoring the ratio of LVP to PAC.

Geographic mix of sales. The relative mix of our business between the United States and Canada impacts the monthly adjusted revenue per pet we receive. Prices for our plan in Canada are generally higher than in the United States, 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 adjusted 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.

Investments to grow our business. We plan to continue to invest to grow our business. Any investments in the development of new technology and continued improvements to our member experience will increase our operating expenses in the near term.

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 increases, in order to compensate for value delivered. The implementation of such initiatives may not always coincide with the timing of price increases resulting in fluctuations in revenue and gross profit in our subscription business segment.

Other business segment. Our other business segment includes revenue and expenses related to our writing of policies for an unaffiliated general agent. This relationship can be canceled by the unaffiliated general agent with 360 days’ notice and we are unlikely to be able to replace it with a similar contract quickly, if at all. A cancellation of this contract would result in the policies and revenue being run off over a period of 12 months and could have a material impact on our results of operations. Our other business segment also includes other programs which include policies not directly marketed to consumers and could result in numerous pets enrolling or canceling at one time. We may enter into additional relationships 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. During the first quarter of 2015, we began reporting certain pets previously included in our subscription business segment in our other business segment due to the characteristics of this business being marketed to enterprises rather than consumers, similar to other arrangements within the other business segment. These pets were previously included in our subscription business segment. Segment information for prior periods has been recast to reflect this change. 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 which are not directly marketed to consumers. Revenue from our other business segment is recognized on a pro rata basis over the enrollment term for each policy.

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 the 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 and developments in claims frequency and severity and the cost of veterinary care, and also includes the cost of administering such claims.

Other cost of revenue

Other cost of revenue for our subscription business segment includes direct and indirect member service expenses, renewal fees to our independent referral network, credit card transaction fees and premium tax expenses. Other cost of revenue for our other business segment includes the commission we pay to the unaffiliated general agent and premium taxes on other policies in this segment.

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 time 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 will 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.

Sales and Marketing

Sales and marketing expenses primarily consist of referral fees paid with respect to newly enrolled pets, print, online and promotional advertising costs, strategic partnership fees and employee compensation and related costs. 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. We expect sales and marketing expenses to increase in absolute dollars, although it may fluctuate as a percentage of revenue. We generally target a ratio of lifetime value of a pet to average pet acquisition cost of 5 to 1.

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 amortization of capitalized software and intangible assets. We expect technology and development expenses to increase in absolute dollars and as a percentage of total revenue in the near term as we continue to devote significant resources to enhance our member experience and, thereafter, decrease as a percentage of revenue.

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 have recently incurred additional expenses as a result of expanding our management team and becoming a public company, and expect to continue to incur additional expenses associated with being a public company, including higher legal, corporate insurance and accounting expenses. We expect general and administrative expenses to increase in absolute dollars and decrease as a percentage of revenue over time.

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. Prior period results have been recast to incorporate the movement of certain pets from the subscription business segment to the other business segment during the first six months of 2015. The period-to-period comparison of financial results is not necessarily indicative of future results.



	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
	(in thousands)
Consolidated Statement of Operations Data:
Revenue:
Subscription business	$	32,208		$	24,912		$	62,264		$	47,773
Other business	3,379			3,178			6,633			5,957
Total revenue	35,587			28,090			68,897			53,730
Cost of revenue:
Subscription business⁽¹⁾	26,661			20,273			51,427			38,661
Other business	3,140			2,667			6,102			5,163
Total cost of revenue	29,801			22,940			57,529			43,824
Gross profit:
Subscription business	5,547			4,639			10,837			9,112
Other business	239			511			531			794
Total gross profit	5,786			5,150			11,368			9,906
Operating expenses:
Sales and marketing⁽¹⁾	3,533			2,810			7,184			5,456
Technology and development⁽¹⁾	2,879			2,553			5,677			4,753
General and administrative⁽¹⁾	3,996			3,292			7,693			6,078
Total operating expenses	10,408			8,655			20,554			16,287
Operating loss	(4,622		)	(3,505		)	(9,186		)	(6,381		)
Interest expense	40			726			285			1,462
Other (income) expense, net	(15		)	(759		)	4			528
Loss before income taxes	(4,647		)	(3,472		)	(9,475		)	(8,371		)
Income tax (benefit) expense	(22		)	7			86			21
Net loss	$	(4,625	)	$	(3,479	)	$	(9,561	)	$	(8,392	)


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



	Three Months Ended June 30,				Six Months Ended June 30,
	2015		2014		2015		2014
	(in thousands)
Cost of revenue	$	58	$	64	$	127	$	145
Sales and marketing	110		144		240		293
Technology and development	93		98		214		196
General and administrative	636		320		1,019		559
Total stock-based compensation expense	$	897	$	626	$	1,600	$	1,193



	Three Months Ended June 30,				Six Months Ended June 30,
	2015		2014		2015		2014
	(as a % of revenue)
Revenue	100	%	100	%	100	%	100	%
Cost of revenue	84		82		84		82
Gross profit	16		18		16		18
Operating expenses:
Sales and marketing	10		10		10		10
Technology and development	8		9		8		9
General and administrative	11		12		11		11
Total operating expenses	29		31		29		30
Operating loss	(13	)	(12	)	(13	)	(12	)
Interest expense	—		3		—		3
Other (income) expense, net	—		(3	)	—		1
Loss before income taxes	(13	)	(12	)	(14	)	(16	)
Income tax expense (benefit)	—		—		—		—
Net loss	(13	)%	(12	)%	(14	)%	(16	)%



	Three Months Ended June 30,				Six Months Ended June 30,
	2015		2014		2015		2014
	(as a % of subscription revenue)
Subscription business revenue	100	%	100	%	100	%	100	%
Subscription business cost of revenue	83		81		83		81
Subscription business gross profit	17	%	19	%	17	%	19	%

Comparison of Three and Six Months Ended June 30, 2015 and 2014

Prior period results have been recast to incorporate the movement of certain pets from the subscription business segment to the other business segment in 2015.

Revenue



	Three Months Ended June 30,						% Change		Six Months Ended June 30,						% Change
	2015			2014			% Change		2015			2014			% Change
	(in thousands, except percentages, pet and per pet data)
Revenue:
Subscription business	$	32,208		$	24,912		29	%	$	62,264		$	47,773		30	%
Other business	3,379			3,178			6		6,633			5,957			11
Total revenue	$	35,587		$	28,090		27		$	68,897		$	53,730		28
Percentage of Revenue by Segment:
Subscription business	91		%	89		%			90		%	89		%
Other business	9			11					10			11
Total revenue	100		%	100		%			100		%	100		%
Subscription Business:
Total pets enrolled (at period end)	259,948			207,969			25		259,948			207,969			25
Subscription pets enrolled (at period end)	241,808			192,338			26		241,808			192,338			26
Monthly adjusted revenue per pet	$	45.10		$	43.60		3		$	44.73		$	43.34		3
Average monthly retention	98.67		%	98.65		%			98.67		%	98.65		%

Three months ended June 30, 2015 compared to three months ended June 30, 2014. Total revenue increased by $7.5 million to $35.6 million for the three months ended June 30, 2015, or 27%. Revenue from our subscription business segment increased by $7.3 million to $32.2 million for the three months ended June 30, 2015, or 29%. This increase in subscription business revenue primarily was due to a 26% increase in subscription pets enrolled as of June 30, 2015 compared to June 30, 2014 and a 6% increase in monthly adjusted revenue per pet (before conversion of Canadian premiums into U.S. Dollars) during the three months ended June 30, 2015 as compared to the three months ended June 30, 2014 as a result of increases in our pricing due to increases in the cost of veterinary care and expansions of our coverage. The impact of these price increases was partially offset by a $1.0 million impact of foreign exchange rates on our Canadian revenue when compared to the three months ended June 30, 2014. Revenue from our other business segment increased $0.2 million to $3.4 million for the three months ended June 30, 2015, due to an increase in enrolled pets in this segment.

Six months ended June 30, 2015 compared to six months ended June 30, 2014. Total revenue increased by $15.2 million to $68.9 million for the six months ended June 30, 2015, or 28%. Revenue from our subscription business segment increased by $14.5 million to $62.3 million for the six months ended June 30, 2015, or 30%. This increase in subscription business revenue primarily was due to a 26% increase in subscription pets enrolled as of June 30, 2015 compared to June 30, 2014 and a 6% increase in monthly adjusted revenue per pet (before conversion of Canadian premiums into U.S. Dollars) during the six months ended June 30, 2015 as compared to the six months ended June 30, 2014 as a result of increases in our pricing due to increases in the cost of veterinary care and expansions of our coverage. The impact of these price increases was partially offset by a $1.9 million impact of foreign exchange rates on our Canadian revenue when compared to the six months ended June 30, 2014. Revenue from our other business segment increased $0.7 million to $6.6 million for the six months ended June 30, 2015, or 11%, due to an increase in enrolled pets in this segment.

Cost of Revenue



	Three Months Ended June 30,				% Change		Six Months Ended June 30,				% Change
	2015		2014		% Change		2015		2014		% Change
	(in thousands, except percentages)
Cost of Revenue:
Subscription business:
Claims expenses	$	23,396	$	17,585	33	%	$	44,898	$	33,482	34	%
Other cost of revenue	3,265		2,688		21		6,529		5,179		26
Total cost of revenue	26,661		20,273		32		51,427		38,661		33
Gross profit	5,547		4,639		20		10,837		9,112		19
Other business:
Claims expenses	2,091		1,392		50		3,940		2,530		56
Other cost of revenue	1,049