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, 2016
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, 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
x
 
Non-accelerated filer
o
(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 October 26, 2016 there were approximately 29,253,857 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 for share and per share data)
(unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
48,359

 
$
37,865

 
$
136,890

 
$
106,762

Cost of revenue:
 
 
 
 
 
 
 
Claims expenses
34,253

 
26,604

 
97,323

 
75,442

Other cost of revenue
5,606

 
4,670

 
15,497

 
13,361

Gross profit
8,500

 
6,591

 
24,070

 
17,959

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
3,892

 
4,128

 
11,296

 
11,312

Technology and development
2,339

 
3,005

 
6,790

 
8,683

General and administrative
3,811

 
4,067

 
11,028

 
11,760

Total operating expenses
10,042


11,200

 
29,114

 
31,755

Operating loss
(1,542
)

(4,609
)
 
(5,044
)
 
(13,796
)
Interest expense
66

 
14

 
137

 
298

Other expense (income), net
16

 
4

 
(39
)
 
8

Loss before income taxes
(1,624
)

(4,627
)
 
(5,142
)
 
(14,102
)
Income tax expense
13


16

 
31

 
102

Net loss
$
(1,637
)
 
$
(4,643
)
 
$
(5,173
)
 
$
(14,204
)

 
 
 
 
 
 
 
Net loss per share attributable to common stockholders:
 
 
 
 
 
 
 
Basic and diluted
$
(0.06
)
 
$
(0.17
)
 
$
(0.18
)
 
$
(0.52
)
Weighted-average shares used to compute net loss per share attributable to common stock holders:
 
 
 
 
 
 
 
Basic and diluted
28,732,417

 
27,755,310

 
28,362,084

 
27,564,975



1


Trupanion, Inc.
Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Net loss
$
(1,637
)
 
$
(4,643
)
 
$
(5,173
)
 
$
(14,204
)
Other comprehensive (loss) income:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(96
)
 
(274
)
 
204

 
(347
)
Change in unrealized losses on available-for-sale securities
25

 
29

 
33

 
(12
)
Other comprehensive (loss) income, net of taxes
(71
)
 
(245
)
 
237

 
(359
)
Comprehensive loss
$
(1,708
)
 
$
(4,888
)
 
$
(4,936
)
 
$
(14,563
)


2


Trupanion, Inc.
Consolidated Balance Sheets
(in thousands, except for share data)
 
September 30, 2016
 
December 31, 2015
Assets
(unaudited)
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
20,626

 
$
17,956

Short-term investments
28,720

 
25,288

Accounts and other receivables
10,286

 
8,196

Prepaid expenses and other assets
1,919

 
2,193

Total current assets
61,551

 
53,633

Long-term investments, at fair value
2,500

 
2,388

Equity method investment
289

 
300

Property and equipment, net
9,188

 
9,719

Intangible assets, net
4,894

 
4,854

Other long term assets
89

 
23

Total assets
$
78,511

 
$
70,917

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
1,284

 
$
1,289

Accrued liabilities
3,489

 
4,189

Claims reserve
8,362

 
6,274

Deferred revenue
13,171

 
11,042

Deferred tax liabilities
169

 
169

Other payables
987

 
654

Total current liabilities
27,462

 
23,617

Long-term debt
3,969

 
—

Deferred tax liabilities
1,433

 
1,433

Other liabilities
858

 
511

Total liabilities
33,722

 
25,561

Stockholders’ equity:
 
 
 
Common stock, $0.00001 par value per share, 100,000,000 shares authorized at September 30, 2016 and 200,000,000 shares authorized at December 31, 2015, 29,870,771 and 29,249,792 shares issued and outstanding at September 30, 2016; 29,017,168 and 28,396,189 shares issued and outstanding at December 31, 2015
—

 
—

Preferred stock: $0.00001 par value per share, 10,000,000 shares authorized at September 30, 2016 and December 31, 2015, and 0 shares issued and outstanding at September 30, 2016 and December 31, 2015
—

 
—

Additional paid-in capital
127,213

 
122,844

Accumulated other comprehensive loss
(265
)
 
(502
)
Accumulated deficit
(79,558
)
 
(74,385
)
Treasury stock, at cost: 620,979 shares at September 30, 2016 and December 31, 2015
(2,601
)
 
(2,601
)
Total stockholders’ equity
44,789

 
45,356

Total liabilities and stockholders’ equity
$
78,511

 
$
70,917



3


Trupanion, Inc.
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
 
 
 
 
Nine Months Ended September 30,
 
2016
 
2015
Operating activities
 
 
 
Net loss
$
(5,173
)
 
$
(14,204
)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
2,617

 
1,800

Stock-based compensation expense
2,215

 
2,349

Other, net
218

 
(86
)
Changes in operating assets and liabilities:
 
 
 
Accounts and other receivables
(2,023
)
 
(504
)
Prepaid expenses and other assets
217

 
(868
)
Accounts payable
(31
)
 
(329
)
Accrued liabilities
(700
)
 
53

Claims reserve
2,043

 
1,127

Deferred revenue
2,079

 
1,310

Other payables
106

 
(416
)
Net cash provided by (used in) operating activities
1,568

 
(9,768
)
Investing activities
 
 
 
Purchases of investment securities
(15,992
)
 
(16,082
)
Maturities of investment securities
12,577

 
13,580

Equity method investment
—

 
(300
)
Purchases of property and equipment
(1,546
)
 
(3,816
)
Other
(130
)
 
—

Net cash used in investing activities
(5,091
)
 
(6,618
)
Financing activities
 
 
 
Tax withholding on restricted stock
(662
)
 
(643
)
Proceeds from exercise of stock options
2,736

 
914

Proceeds from (repayment of) debt financing
3,988

 
(14,900
)
Payments on capital lease obligations
(110
)
 
—

Net cash provided by (used in) financing activities
5,952

 
(14,629
)
Effect of foreign exchange rates on cash, net
241

 
(395
)
Net change in cash and cash equivalents
2,670

 
(31,410
)
Cash and cash equivalents at beginning of period
17,956

 
53,098

Cash and cash equivalents at end of period
$
20,626

 
$
21,688

Supplemental disclosures
 
 
 
Income taxes paid
12

 
117

Interest paid
92

 
155

Noncash investing and financing activities:
 
 
 
Increase in payables for property and equipment
81

 
310

Property and equipment acquired under capital leases
615

 
—



4


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) provides medical insurance plans for cats and dogs throughout the United States, Canada and Puerto Rico.
Basis of Presentation
The consolidated balance sheet data as of December 31, 2015 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, 2015 included in the Company’s Annual Report on Form 10-K, filed with the U.S Securities and Exchange Commission on February 17, 2016. 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 nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016, or for any other period.
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, useful lives of software developed for internal use and income tax uncertainties. Actual results could differ from the estimates used in preparing the consolidated financial statements.
Accumulated Other Comprehensive Loss
There were no reclassifications out of accumulated other comprehensive loss during the three and nine months ended September 30, 2016 and 2015.
Recent Accounting Pronouncements
In May 2015, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) amending short-term insurance contract 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. The Company plans to adopt this guidance as of December 31, 2016. The Company has determined that although this guidance will not impact the operating results, financial condition or cash flows, additional disclosures will be required in the Company's Form 10-K and Form 10-Q upon adoption.
In November 2015, the FASB issued an ASU amending the accounting for income taxes and requiring all deferred tax assets and liabilities be classified as non-current on the consolidated balance sheet. The ASU is effective for reporting periods beginning after December 15, 2016, with early adoption permitted. The ASU may be adopted either prospectively or retrospectively. The Company plans to prospectively adopt this guidance as of January 1, 2017. The Company anticipates that this guidance will not have a material impact on the financial statements resulting from the reclassification of deferred taxes to non-current. The Company will continue to monitor the impact of this guidance.
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 balance sheet. 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 is in the process of assessing the impact of this guidance.

5


In March 2016, the FASB issued an ASU amending the accounting for employee share-based payments, including income tax recognition and classification. The entity may make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. Additionally, tax withholding of shares will be allowed up to the employees’ maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award. This ASU is effective for fiscal years beginning after December 15, 2016 including interim periods within that reporting period, with early adoption permitted. The Company plans to adopt this guidance as of January 1, 2017. The Company has determined the guidance for estimating forfeitures does not currently have a material impact to the financial statements; however, the Company will continue to monitor the impact of this guidance.
In August 2016, the FASB issued an ASU which addresses eight specific cash flow issues intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This ASU is effective for fiscal periods beginning after December 15, 2017 including interim periods within that reporting period, with early adoption permitted. The Company plans to adopt this guidance as of January 1, 2018. The Company is in the process of assessing the impact of this guidance.
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 unvested restricted stock, stock options, and warrants. 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 were not included in the diluted net loss per common share calculation because they would have had an antidilutive effect:
 
As of September 30,
 
2016
 
2015
Stock options
4,354,494

 
4,991,047

Restricted stock awards and units
355,329

 
474,522

Warrants
869,999

 
869,999


6


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 September 30, 2016 and December 31, 2015 (in thousands):
 
Amortized
Cost
 
Gross
Unrealized
Holding
Losses
 
Fair
Value
As of September 30, 2016
 
 
 
 
 
       Available-for-sale:
 
 
 
 
 
Foreign deposits
$
1,521

 
$
—

 
$
1,521

              Municipal bond
1,000

 
(21
)
 
979

 
$
2,521

 
$
(21
)
 
$
2,500

       Short-term investments:
 
 
 
 
 
              U.S. Treasury securities
$
5,786

 
$
—

 
$
5,786

              Certificates of deposit
708

 
—

 
708

              U.S. government funds
22,226

 
—

 
22,226

 
$
28,720


$
—


$
28,720

 
 
 
 
 
 
 
Amortized
Cost
 
Gross
Unrealized
Holding
Losses
 
Fair
Value
As of December 31, 2015
 
 
 
 
 
Available-for-sale:
 
 
 
 
 
Foreign deposits
$
1,442

 
$
—

 
$
1,442

Municipal bond
1,000

 
(54
)
 
946

 
$
2,442


$
(54
)

$
2,388

Short-term investments:
 
 
 
 
 
U.S. Treasury securities
$
5,683

 
$
—

 
$
5,683

Certificates of deposit
1,551

 
—

 
1,551

U.S. government funds
18,054

 
—

 
18,054

 
$
25,288


$
—


$
25,288

Maturities of debt securities classified as available-for-sale were as follows (in thousands):
 
September 30, 2016
 
Amortized
Cost
 
Fair
Value
Available-for-sale:
 
 
 
Due under one year
$
—

 
$
—

Due after one year through five years
1,521

 
1,521

Due after five years through ten years
1,000

 
979

Due after ten years
—

 
—

 
$
2,521

 
$
2,500

The Company had one investment with an unrealized loss of less than $0.1 million and a fair value of $1.0 million at September 30, 2016, and an unrealized loss of $0.1 million and a fair value of $0.9 million at December 31, 2015. 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.

7


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 September 30, 2016
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Foreign deposits
$
1,521

 
$
1,521

 
$
—

 
$
—

Municipal bond
979

 
—

 
979

 
—

Money market funds
7,325

 
7,325

 
—

 
—

Total
$
9,825

 
$
8,846

 
$
979

 
$
—

 
 
 
 
 
 
 
 
 
As of December 31, 2015
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Foreign deposits
$
1,442

 
$
1,442

 
$
—

 
$
—

Municipal bond
946

 
—

 
946

 
—

Money market funds
7,545

 
7,545

 
—

 
—

Total
$
9,933

 
$
8,987

 
$
946

 
$
—

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 September 30, 2016.
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 nine months ended September 30, 2016 and 2015.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
•
Investment securities: Long-term investments 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. Short-term investments 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.

8


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 4.5%, or 1.25% 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 2018, or such extended maturity date if the revolving line of credit is automatically renewed. The revolving line of credit auto-renews annually unless canceled by the bank. The credit agreement requires the Company to comply with various financial and non-financial covenants. As of September 30, 2016, the Company was in compliance with all covenants. This facility also currently has a compensating balance requirement of $0.5 million and an irrevocable standby letter of credit totaling $1.1 million, which reduces the amount available on the line of credit. As of September 30, 2016, the Company had $14.4 million available under its revolving line of credit.
Borrowings on the revolving line of credit are limited to the lesser of $20.0 million in 2016 and 2015, and the total amount of cash and securities held by the Company's subsidiary, American Pet Insurance Company (APIC), less up to $3.0 million for obligations the Company may have outstanding for other ancillary services in the future. As of September 30, 2016, the Company had $4.0 million outstanding under this facility.
6. Commitments and Contingencies
During 2016, the Company entered into strategic marketing and service provider agreements, as well as other agreements with various parties. As of the September 30, 2016, these agreements resulted in an increase in future commitments from December 31, 2015 of $0.8 million for the remainder of 2016, $0.6 million in 2017 and $0.3 million in 2018.
During 2016, the Company entered into a capital lease agreement. As of September 30, 2016, this agreement resulted in an increase in future commitments of $0.1 million for the remainder of 2016, $0.3 million in 2017 and $0.2 million in 2018.
The outcomes of the Company’s legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to the Company's 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, 2015
4,871,949

 
$
3.71

 
$
29,644

Granted
630,773

 
13.24

 
 
Exercised
(894,572
)
 
3.06

 
9,269

Forfeited
(253,656
)
 
7.79

 
 
September 30, 2016
4,354,494

 
4.99

 
51,855

 
 
 
 
 
 
Vested and exercisable at September 30, 2016
3,197,604

 
$
2.95

 
$
44,595

As of September 30, 2016, the stock options outstanding had a remaining contractual life of 5.9 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 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 350,631 shares of unvested restricted stock measured on a graded vesting schedule are expected to vest over the remaining service term of approximately 3.0 years.

9


As of September 30, 2016, the Company had unrecognized stock-based compensation expense of $5.9 million, which is expected to vest over a weighted-average period of approximately 2.6 years. As of September 30, 2016, the Company had 1,122,183 unvested stock options and 355,329 restricted stock awards and units 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 September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Claims expenses
$
74

 
$
58

 
$
189

 
$
160

Other cost of revenue
9

 
10

 
26

 
35

Sales and marketing
172

 
102

 
419

 
342

Technology and development
67

 
97

 
158

 
311

General and administrative
454

 
482

 
1,423

 
1,501

Total stock-based compensation expense
$
776

 
$
749

 
$
2,215

 
$
2,349


10


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.
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,
 
2016
 
2015
 
2016
 
2015
Revenue:
 
 
 
 
 
 
 
Subscription business
$
44,629

 
$
34,420

 
$
125,934

 
$
96,684

Other business
3,730

 
3,445

 
10,956

 
10,078

 
48,359

 
37,865

 
136,890

 
106,762

Claims expenses:
 
 
 
 
 
 
 
Subscription business
32,088

 
24,455

 
90,709

 
69,352

Other business
2,165

 
2,149

 
6,614

 
6,090

 
34,253

 
26,604

 
97,323

 
75,442

Other cost of revenue:
 
 
 
 
 
 
 
Subscription business
4,344

 
3,691

 
12,084

 
10,220

Other business
1,262

 
979

 
3,413

 
3,141

 
5,606

 
4,670

 
15,497

 
13,361

Gross profit:
 
 
 
 
 
 
 
Subscription business
8,197

 
6,274

 
23,141

 
17,112

Other business
303


317

 
929

 
847

 
8,500


6,591

 
24,070

 
17,959

Sales and marketing:
 
 
 
 
 
 
 
Subscription business
3,829

 
4,112

 
11,140

 
11,240

Other business
63

 
16

 
156

 
72

 
3,892

 
4,128

 
11,296

 
11,312

Technology and development
2,339

 
3,005

 
6,790

 
8,683

General and administrative
3,811

 
4,067

 
11,028

 
11,760

Operating loss
$
(1,542
)

$
(4,609
)
 
$
(5,044
)
 
$
(13,796
)
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,
 
2016
 
2015
 
2016
 
2015
United States
$
38,799

 
$
30,009

 
$
110,024

 
$
83,607

Canada
9,560

 
7,856

 
26,866

 
23,155

Total revenue
$
48,359

 
$
37,865

 
$
136,890

 
$
106,762

Substantially all of the Company’s long-lived assets were located in the United States as of September 30, 2016 and December 31, 2015.

11


Item 2. - Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We provide 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 for their pets, priced specifically for each pet’s unique characteristics. Our growing and loyal member base provides us with highly predictable and recurring revenue. We operate our business similar to other subscription-based businesses, with a focus on maximizing the lifetime value of each pet while sustaining a favorable ratio of lifetime value relative to pet 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 writing policies which we do not directly market to consumers. These operations include policies that provide different coverage and are subject to materially different terms and conditions than our primary medical plan.
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 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 $106.8 million for the nine months ended September 30, 2015 to $136.9 million for the nine months ended September 30, 2016, 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 nine months ended September 30, 2016 and 2015, we had a net loss of $5.2 million and $14.2 million respectively. As of September 30, 2016, our accumulated deficit was $79.6 million.

12


Key Financial and Operating Metrics
The following tables set forth our key financial and operating metrics for the periods ended September 30, 2016 and 2015 and for each of the last eight fiscal quarters.
 
Nine Months Ended September 30,
 
2016
 
2015
Total pets enrolled (at period end)
334,070

 
276,988

Total subscription pets enrolled (at period end)
312,282

 
258,546

Monthly average revenue per pet
$
47.33

 
$
44.88

Lifetime value of a pet (LVP)
$
624

 
$
591

Average pet acquisition cost (PAC)
$
120

 
$
132

Average monthly retention
98.61
%
 
98.66
%
Adjusted EBITDA (in thousands)
$
(240
)
 
$
(9,711
)
 
Three Months Ended
 
Sept. 30, 2016
 
Jun. 30, 2016
 
Mar. 31, 2016
 
Dec. 31, 2015
 
Sept. 30, 2015
 
Jun. 30, 2015
 
Mar. 31, 2015
 
Dec. 31, 2014
Total pets enrolled (at period end)
334,070

 
320,896

 
307,298

 
291,818

 
276,988

 
259,948

 
246,106

 
232,450

Total subscription pets enrolled (at period end)
312,282

 
299,856

 
287,123

 
272,636

 
258,546

 
241,808

 
228,409

 
215,491

Monthly average revenue per pet
$
48.37

 
$
47.39

 
$
46.12

 
$
45.48

 
$
45.15

 
$
45.10

 
$
44.34

 
$
44.79

Lifetime value of a pet (LVP)
$
624

 
$
622

 
$
603

 
$
591

 
$
591

 
$
570

 
$
567

 
$
591

Average pet acquisition cost (PAC)
$
120

 
$
118

 
$
123

 
$
132

 
$
129

 
$
133

 
$
134

 
$
145

Average monthly retention
98.61
%
 
98.64
%
 
98.65
%
 
98.64
%
 
98.66
%
 
98.67
%
 
98.66
%
 
98.69
%
Adjusted EBITDA (in thousands)
$
304

 
$
522

 
$
(1,066
)
 
$
(1,588
)
 
$
(3,211
)
 
$
(3,165
)
 
$
(3,333
)
 
$
(2,903
)
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 Trupanion 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 unit economics of our business.
Lifetime value of a pet. Lifetime value of a pet (LVP) is calculated in part based on gross profit from our subscription business segment for the 12 months prior to the period end date excluding stock-based compensation expense related to cost of revenue from our subscription business segment, sign-up fee revenue and the change in deferred revenue between periods, 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.

13


Average pet acquisition cost. 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, 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 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 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, 2016 is an average of each month’s retention from October 1, 2015 through September 30, 2016. 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 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, income tax expense (benefit) and loss (income) from equity method investment. 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 acquisition cost, net acquisition cost and adjusted EBITDA 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 expense, 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. We define adjusted EBITDA as net loss excluding stock-based compensation expense, depreciation and amortization expense, interest income, interest expense, income tax expense (benefit) and loss (income) from equity method investment.
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 acquisition cost, net acquisition cost and adjusted EBITDA that exclude stock-based compensation expense and, in the case of adjusted EBITDA, loss (income) from equity method investments 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, 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.

14



The following tables reflect the reconciliation of acquisition cost and net acquisition cost to sales and marketing expense:
 
Nine Months Ended September 30,
 
2016
 
2015
 
(in thousands)
Sales and marketing expense
$
11,296

 
$
11,312

Excluding:
 
 
 
    Stock-based compensation expense
(419
)
 
(342
)
Acquisition cost
10,877

 
10,970

Net of:
 
 
 
    Sign-up fee revenue
(1,547
)
 
(1,477
)
    Other business segment sales and marketing expense
(156
)
 
(72
)
Net acquisition cost
$
9,174

 
$
9,421

 
Three Months Ended
 
Sept. 30, 2016
 
Jun. 30, 2016
 
Mar. 31, 2016
 
Dec. 31, 2015
 
Sept. 30, 2015
 
Jun. 30, 2015
 
Mar. 31, 2015
 
Dec. 31, 2014
 
(in thousands)
Sales and marketing expense
$
3,892

 
$
3,564

 
$
3,840

 
$
3,919

 
$
4,128

 
$
3,533

 
$
3,651

 
$
3,218

Excluding:
 
 

 
 
 
 
 
 
 
 
 
 
 
 
    Stock-based compensation expense
(172
)
 
(165
)
 
(82
)
 
(104
)
 
(102
)
 
(110
)
 
(130
)
 
(147
)
Acquisition cost
3,720

 
3,399

 
3,758

 
3,815

 
4,026

 
3,423

 
3,521

 
3,071

Net of:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    Sign-up fee revenue
(525
)
 
(495
)
 
(527
)
 
(506
)
 
(542
)
 
(451
)
 
(484
)
 
(363
)
    Other business segment sales and marketing expense
(63
)
 
(55
)
 
(38
)
 
(8
)
 
(16
)
 
(30
)
 
(26
)
 
(30
)
Net acquisition cost
$
3,132

 
$
2,849

 
$
3,193

 
$
3,301

 
$
3,468

 
$
2,942

 
$
3,011

 
$
2,678

The following tables reflect the reconciliation of adjusted EBITDA to net loss:
 
Nine Months Ended September 30,
 
2016
 
2015
 
(in thousands)
Net loss
$
(5,173
)
 
$
(14,204
)
Excluding:
 
 
 
Stock-based compensation expense
2,215

 
2,349

Depreciation and amortization expense
2,617

 
1,800

Interest income
(78
)
 
(56
)
Interest expense
137

 
298

Income tax expense (benefit)
31

 
102

Loss (income) from equity method investment
11

 
—

Adjusted EBITDA
$
(240
)
 
$
(9,711
)

15


 
Three Months Ended
 
Sept. 30, 2016
 
Jun. 30, 2016
 
Mar. 31, 2016
 
Dec. 31, 2015
 
Sept. 30, 2015
 
Jun. 30, 2015
 
Mar. 31, 2015
 
Dec. 31, 2014
 
(in thousands)
Net loss
$
(1,637
)
 
$
(964
)
 
$
(2,572
)
 
$
(3,001
)
 
$
(4,643
)
 
$
(4,625
)
 
$
(4,936
)
 
$
(4,276
)
Excluding:
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Stock-based compensation expense
776

 
743

 
696

 
653

 
749

 
897

 
703

 
890

Depreciation and amortization expense
1,093

 
739

 
785

 
741

 
672

 
563

 
566

 
441

Interest income
(29
)
 
(26
)
 
(23
)
 
(19
)
 
(19
)
 
(18
)
 
(19
)
 
(18
)
Interest expense
66

 
41

 
30

 
26

 
14

 
40

 
245

 
103

Income tax expense (benefit)
13

 
4

 
14

 
12

 
16

 
(22
)
 
108

 
(43
)
Loss (income) from equity method investment
22

 
(15
)
 
4

 
—

 
—

 
—

 
—

 
—

Adjusted EBITDA
$
304

 
$
522

 
$
(1,066
)
 
$
(1,588
)
 
$
(3,211
)
 
$
(3,165
)
 
$
(3,333
)
 
$
(2,903
)
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. For example, the timing of our Territory Partner conference may increase our average pet acquisition cost in a given period (historically, during the fourth quarter of each year). We also regularly test new member acquisition channels and marketing initiatives, which may be more expensive than our traditional marketing channels and increase our average acquisition costs. We plan to expand the number of Territory Partners and continue testing new member acquisition channels and marketing initiatives, 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.
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.

16


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 within 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 revenue and expenses related to policies written under a federal government program, which has similar risks related to cancellation and renewal. 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. 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 we do not directly market to consumers. These operations include policies that provide different coverage and are subject to materially different terms and conditions than our primary 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 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 Territory Partners, 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, premium taxes on other policies in this segment and other expenses related to the administration of these policies.
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.

17


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 lead generation costs, converting leads to enrolled pets, 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 in new member acquisition channels and marketing initiatives are generally more expensive than our traditional marketing channels and increase our average pet acquisition cost. 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 capitalized software and amortization of intangible assets. We expect technology and development expenses to decrease as a percentage of revenue in the near term 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,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Consolidated Statement of Operations Data:
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
Subscription business
$
44,629


$
34,420

 
$
125,934

 
$
96,684

Other business
3,730


3,445

 
10,956

 
10,078

Total revenue
48,359


37,865

 
136,890

 
106,762

Cost of revenue:
 
 
 
 
 
 
 
Subscription business(1)
36,432

 
28,146

 
102,793

 
79,572

Other business
3,427

 
3,128

 
10,027

 
9,231

Total cost of revenue
39,859

 
31,274

 
112,820

 
88,803

Gross profit:
 
 
 
 
 
 
 
Subscription business
8,197

 
6,274

 
23,141

 
17,112

Other business
303

 
317

 
929

 
847

Total gross profit
8,500


6,591

 
24,070

 
17,959

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing(1)
3,892

 
4,128

 
11,296

 
11,312

Technology and development(1)
2,339

 
3,005

 
6,790

 
8,683

General and administrative(1)
3,811

 
4,067

 
11,028

 
11,760

Total operating expenses
10,042

 
11,200

 
29,114

 
31,755

Operating loss
(1,542
)

(4,609
)
 
(5,044
)
 
(13,796
)
Interest expense
66

 
14

 
137

 
298

Other expense (income), net
16

 
4

 
(39
)
 
8

Loss before income taxes
(1,624
)
 
(4,627
)
 
(5,142
)
 
(14,102
)
Income tax expense
13

 
16

 
31

 
102

Net loss
$
(1,637
)
 
$
(4,643
)
 
$
(5,173
)
 
$
(14,204
)
(1)
Includes stock-based compensation expense as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Cost of revenue
$
83

 
$
68

 
$
215

 
$
195

Sales and marketing
172

 
102

 
419

 
342

Technology and development
67

 
97

 
158

 
311

General and administrative
454

 
482

 
1,423

 
1,501

Total stock-based compensation expense
$
776

 
$
749

 
$
2,215

 
$
2,349



19


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(as a % of revenue)
Revenue
100
 %
 
100
 %
 
100
 %
 
100
 %
Cost of revenue
82

 
83

 
82

 
83

Gross profit
18

 
17

 
18

 
17

Operating expenses:

 

 
 
 
 
Sales and marketing
8

 
11

 
8

 
11

Technology and development
5

 
8

 
5

 
8

General and administrative
8

 
11

 
8

 
11

Total operating expenses
21

 
30

 
21

 
30

Operating loss
(3
)
 
(12
)
 
(3
)
 
(13
)
Interest expense
—

 
—

 
—

 
—

Other expense (income), net
—

 
—

 
—

 
—

Loss before income taxes
(3
)
 
(12
)
 
(3
)
 
(13
)
Income tax expense
—

 
—

 
—

 
—

Net loss
(3
)%
 
(12
)%
 
(3
)%
 
(13
)%

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(as a % of subscription revenue)
Subscription business revenue
100
%
 
100
%
 
100
%
 
100
%
Subscription business cost of revenue
82

 
82

 
82

 
82

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


20


Comparison of Three and Nine Months Ended September 30, 2016 and 2015

Revenue
 
Three Months Ended September 30,
 
% Change
 
Nine Months Ended September 30,
 
% Change
 
2016
 
2015
 
 
2016
 
2015
 
 
(in thousands, except percentages, pet and per pet data)
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Subscription business
$
44,629

 
$
34,420

 
30
%
 
$
125,934

 
$
96,684

 
30
%
Other business
3,730

 
3,445

 
8

 
10,956

 
10,078

 
9

Total revenue
$
48,359

 
$
37,865

 
28

 
$
136,890

 
$
106,762

 
28

Percentage of Revenue by Segment:
 
 
 
 


 
 
 
 
 
 
Subscription business
92
%
 
91
%
 


 
92
%
 
91
%
 
 
Other business
8

 
9

 


 
8

 
9

 
 
Total revenue
100
%
 
100
%
 


 
100
%
 
100
%
 
 
Subscription Business:
 
 
 
 


 
 
 
 
 
 
Total pets enrolled (at period end)
334,070

 
276,988

 
21

 
334,070

 
276,988

 
21

Total subscription pets enrolled (at period end)
312,282

 
258,546

 
21

 
312,282

 
258,546

 
21

Monthly average revenue per pet
$
48.37

 
$
45.15

 
7

 
$
47.33

 
$
44.88

 
5

Average monthly retention
98.61
%
 
98.66
%
 
 
 
98.61
%
 
98.66
%
 
 
Three months ended September 30, 2016 compared to three months ended September 30, 2015. Total revenue increased by $10.5 million to $48.4 million for the three months ended September 30, 2016, or 28%. Revenue from our subscription business segment increased by $10.2 million to $44.6 million for the three months ended September 30, 2016, or 30%. This increase in subscription business revenue was primarily due to a 21% increase in total subscription pets enrolled as of September 30, 2016 compared to September 30, 2015, and increased average revenue per pet of 7% for the same period due to increases in pricing to cover the increased cost of veterinary care. The impact of the increase was partially offset by an approximate $0.4 million negative impact on our Canadian revenue due to changes in foreign exchange rates when compared to the three months ended September 30, 2015. Revenue from our other business segment increased $0.3 million to $3.7 million for the three months ended September 30, 2016, or 8%, due to an increase in enrolled pets in this segment.
Nine months ended September 30, 2016 compared to nine months ended September 30, 2015. Total revenue increased by $30.1 million to $136.9 million for the nine months ended September 30, 2016, or 28%. Revenue from our subscription business segment increased by $29.2 million to $125.9 million for the nine months ended September 30, 2016, or 30%. This increase in subscription business revenue was primarily due to a 21% increase in total subscription pets enrolled as of September 30, 2016 compared to September 30, 2015, and increased average revenue per pet of 5% for the same period due to increases in pricing to cover the increased cost of veterinary care. The impact of the increase was partially offset by an approximate $1.2 million negative impact on our Canadian revenue due to changes in foreign exchange rates when compared to the nine months ended September 30, 2015. Revenue from our other business segment increased $0.9 million to $11.0 million for the nine months ended September 30, 2016, or 9%, 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
 
2016
 
2015
 
 
2016
 
2015
 
 
(in thousands, except percentages and pet data)
Cost of Revenue:
 
 
 
 
 
 
 
 
 
 
 
Subscription business:
 
 
 
 
 
 
 
 
 
 
 
Claims expenses
$
32,088

 
$
24,455

 
31
 %
 
$
90,709

 
$
69,352

 
31
%
Other cost of revenue
4,344

 
3,691

 
18

 
12,084

 
10,220

 
18

Total cost of revenue
36,432

 
28,146

 
29

 
102,793

 
79,572

 
29

Gross profit
8,197

 
6,274

 
31

 
23,141

 
17,112

 
35

Other business:
 
 
 
 


 
 
 
 
 
 
Claims expenses
2,165

 
2,149

 
1

 
6,614

 
6,090

 
9

Other cost of revenue
1,262

 
979

 
29

 
3,413

 
3,141

 
9

Total cost of revenue
3,427

 
3,128

 
10

 
10,027

 
9,231

 
9

Gross profit
303

 
317

 
(4
)
 
929

 
847

 
10

Total pets enrolled (at period end)
334,070

 
276,988

 
21

 
334,070

 
276,988

 
21

Total subscription pets enrolled (at period end)
312,282

 
258,546

 
21

 
312,282

 
258,546

 
21

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

 
11

 
 
 
10

 
11

 
 
Total cost of revenue
82

 
82

 
 
 
82

 
82

 
 
Gross profit
18

 
18

 
 
 
18

 
18

 
 
Other business:
 
 
 
 
 
 
 
 
 
 
 
Claims expenses
58

 
62

 
 
 
60

 
60

 
 
Other cost of revenue
34

 
28

 
 
 
31

 
31

 
 
Total cost of revenue
92

 
91

 
 
 
92

 
92

 
 
Gross profit
8

 
9

 
 
 
8

 
8

 
 
Three months ended September 30, 2016 compared to three months ended September 30, 2015. Cost of revenue for our subscription business segment was $36.4 million, or 82% of revenue, for the three months ended September 30, 2016, compared to $28.1 million, or 82% of revenue, for the three months ended September 30, 2015. This $8.3 million increase in subscription cost of revenue was primarily the result of a 21% increase in total subscription pets enrolled and an increase in the cost of veterinary care. Claims expenses were 72% of revenue for the three months ended September 30, 2016 and 71% of revenue for the three months end September 30, 2015 due to normal variation in claims expenses. Additionally, personnel costs and related expenses increased by $0.6 million due to an increase in employee headcount to service our growth. Cost of revenue for our other business segment increased $0.3 million to $3.4 million for the three months ended September 30, 2016, due to an increase in enrolled pets in this segment.
Nine months ended September 30, 2016 compared to nine months ended September 30, 2015. Cost of revenue for our subscription business segment was $102.8 million, or 82% of revenue, for the nine months ended September 30, 2016, compared to $79.6 million, or 82% of revenue, for the nine months ended September 30, 2015. This $23.2 million increase in subscription cost of revenue was primarily the result of a 21% increase in total subscription pets enrolled and increases in the cost of veterinary care. Claims expenses remained consistent at 72% of revenue for the nine months ended September 30, 2016 and 2015. Personnel costs and related expenses increased by $1.5 million due to an increase in employee headcount to service our growth. There was a $1.0 million benefit of foreign exchange rates on our Canadian costs. Cost of revenue for our other business segment increased $0.8 million to $10.0 million for the nine months ended September 30, 2016, due to an increase in enrolled pets in this segment.

22



Sales and Marketing Expenses
 
Three Months Ended September 30,
 
% Change
 
Nine Months Ended September 30,
 
% Change
 
2016
 
2015
 
 
2016
 
2015
 
 
(in thousands, except percentages, pet and per pet data)
Sales and marketing
$
3,892

 
$
4,128

 
(6
)%
 
$
11,296

 
$
11,312

 
—
 %
Percentage of total revenue
8
%
 
11
%
 
 
 
8
%
 
11
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Subscription Business:
 
 
 
 
 
 
 
 
 
 
 
Total subscription pets enrolled (at period end)
312,282

 
258,546

 
21

 
312,282

 
258,546

 
21

Average pet acquisition cost (PAC)
$
120

 
$
129

 
(7
)
 
$
120

 
$
132

 
(9
)
Lifetime value of a pet (LVP)
$
624

 
$
591

 
6

 
$
624

 
$
591

 
6

Three months ended September 30, 2016 compared to three months ended September 30, 2015. Sales and marketing expenses decreased $0.2 million to $3.9 million for the three months ended September 30, 2016, or 6%. Expenses decreased due to a slight decrease in expenditures related to online, print, and other marketing initiatives. Our LVP to PAC ratio increased from 4.6:1 to 5.2:1 for the three months ended September 30, 2016.
Nine months ended September 30, 2016 compared to nine months ended September 30, 2015. Sales and marketing expenses remained consistent at $11.3 million for the nine months ended September 30, 2016 and 2015. Our LVP to PAC ratio increased from 4.5:1 to 5.2:1 for the nine months ended September 30, 2016.

Technology and Development Expenses
 
Three Months Ended September 30,
 
% Change
 
Nine Months Ended September 30,
 
% Change
 
2016