Edgar Filing: TRUPANION INC.

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 March 31, 2018

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____ to ____

Commission File Number: 001-36537

TRUPANION, INC.

(Exact name of registrant as specified in its charter)



Delaware		83-0480694
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

6100 4th Avenue S, Suite 200

Seattle, Washington 98108

(855) 727 - 9079

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. xYes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.



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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No

As of April 25, 2018, there were approximately 31,186,900 shares of the registrant’s common stock outstanding.

TRUPANION, INC.

Quarterly Report on Form 10-Q

For the Period Ended March 31, 2018

TABLE OF CONTENTS



		Page

PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25
Item 4.	Controls and Procedures	26
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 2.	Unregistered Sale of Equity Securities and Use of Proceeds	52
Item 3.	Defaults Upon Senior Securities	52
Item 4.	Mine Safety Disclosures	52
Item 5.	Other Information	52
Item 6.	Exhibits	52
	Exhibit Index	53
	Signatures	54

Note About Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and section 27A of the Securities Act of 1933, as amended (Securities Act). 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 “we,” “us,” “our” and similar references refer to Trupanion, Inc. and its subsidiaries taken as a whole.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

TRUPANION, INC. Consolidated Statements of Operations (in thousands, except share data) (unaudited)

	Three Months Ended March 31,
	2018			2017
Revenue	$	69,760		$	54,729
Cost of revenue:
Veterinary invoice expense	50,113			39,187
Other cost of revenue	8,583			6,387
Gross profit	11,064			9,155
Operating expenses:
Technology and development	2,164			2,403
General and administrative	4,458			4,012
Sales and marketing	5,938			4,089
Total operating expenses	12,560			10,504
Operating loss	(1,496		)	(1,349		)
Interest expense	219			137
Other (income) expense, net	(140		)	(28		)
Loss before income taxes	(1,575		)	(1,458		)
Income tax (benefit) expense	(95		)	24
Net loss	$	(1,480	)	$	(1,482	)

Net loss per share:
Basic and diluted	$	(0.05	)	$	(0.05	)
Weighted-average common shares outstanding:
Basic and diluted	30,246,585			29,254,681

See accompanying notes to the consolidated financial statements.

TRUPANION, INC. Consolidated Statements of Comprehensive Loss (in thousands) (unaudited)

	Three Months Ended March 31,
	2018			2017
Net loss	$	(1,480	)	$	(1,482	)
Other comprehensive (loss) income:
Foreign currency translation adjustments	(190		)	12
Net unrealized (loss) on available-for-sale debt securities	(15		)	(7		)
Other comprehensive (loss) income, net of taxes	(205		)	5
Comprehensive loss	$	(1,685	)	$	(1,477	)

See accompanying notes to the consolidated financial statements.

TRUPANION, INC. Consolidated Balance Sheets (in thousands, except share data)

	March 31, 2018			December 31, 2017
Assets	(unaudited)
Current assets:
Cash and cash equivalents	$	30,786		$	25,706
Short-term investments	39,360			37,590
Accounts and other receivables	24,317			20,367
Prepaid expenses and other assets	3,046			2,895
Total current assets	97,509			86,558
Restricted cash	600			600
Long-term investments, at fair value	3,238			3,237
Property and equipment, net	8,275			7,868
Intangible assets, net	5,000			4,972
Other long-term assets	2,596			2,624
Total assets	$	117,218		$	105,859
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	3,343		$	2,716
Accrued liabilities and other current liabilities	8,347			7,660
Reserve for veterinary invoices	13,450			12,756
Deferred revenue	26,757			22,734
Total current liabilities	51,897			45,866
Long-term debt	14,851			9,324
Deferred tax liabilities	1,002			1,002
Other liabilities	1,221			1,233
Total liabilities	68,971			57,425
Stockholders’ equity:
Common stock: $0.00001 par value, 100,000,000 shares authorized; 31,181,627 and 30,430,915 shares issued and outstanding at March 31, 2018; 30,778,796 and 30,121,496 shares issued and outstanding at December 31, 2017	—			—
Preferred stock: $0.00001 par value, 10,000,000 shares authorized; no shares issued and outstanding	—			—
Additional paid-in capital	139,009			134,511
Accumulated other comprehensive loss	(297		)	(92		)
Accumulated deficit	(84,264		)	(82,784		)
Treasury stock, at cost: 755,985 shares at March 31, 2018 and 657,300 shares at December 31, 2017	(6,201		)	(3,201		)
Total stockholders’ equity	48,247			48,434
Total liabilities and stockholders’ equity	$	117,218		$	105,859

See accompanying notes to the consolidated financial statements.

TRUPANION, INC. Consolidated Statements of Cash Flows (in thousands) (unaudited)

	Three Months Ended March 31,
	2018			2017
Operating activities
Net loss	$	(1,480	)	$	(1,482	)
Adjustments to reconcile net loss to cash provided by operating activities:
Depreciation and amortization	927			1,036
Stock-based compensation expense	968			781
Other, net	23			97
Changes in operating assets and liabilities:
Accounts and other receivables	(3,926		)	(3,372		)
Prepaid expenses and other assets	(129		)	(219		)
Accounts payable, accrued liabilities, and other liabilities	910			(295		)
Reserve for veterinary invoices	743			1,093
Deferred revenue	4,041			4,218
Net cash provided by operating activities	2,077			1,857
Investing activities
Purchases of investment securities	(7,140		)	(5,172		)
Maturities of investment securities	5,300			3,871
Purchases of property and equipment	(992		)	(462		)
Other investments	—			(2,710		)
Net cash used in investing activities	(2,832		)	(4,473		)
Financing activities
Proceeds from exercise of stock options	481			1,037
Proceeds from debt financing, net of financing fees	5,500			—
Other financing	(216		)	(142		)
Net cash provided by financing activities	5,765			895
Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash, net	70			21
Net change in cash, cash equivalents, and restricted cash	5,080			(1,700		)
Cash, cash equivalents, and restricted cash at beginning of period	26,306			24,237
Cash, cash equivalents, and restricted cash at end of period	$	31,386		$	22,537
Supplemental disclosures
Noncash investing and financing activities:
Purchases of property and equipment included in accounts payable and accrued liabilities	680			93
Property and equipment acquired under lease	—			45
Issuance of common stock for cashless exercise of warrants	3,000			—

See accompanying notes to the consolidated financial statements.

TRUPANION, INC.

Notes to the Consolidated Financial Statements (unaudited)

1. Nature of Operations and Significant Accounting Policies

Description of Business and Basis of Presentation

Trupanion, Inc. (collectively with its wholly-owned subsidiaries, the Company) provides medical insurance for cats and dogs throughout the United States, Canada and Puerto Rico.

The financial data as of December 31, 2017 was derived from the Company's audited consolidated financial statements. The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and, in management's opinion, have been prepared on the same basis as the audited financial statements and include all adjustments, consisting of normal recurring adjustments, necessary for the fair presentation of the Company's financial position, results of operations, comprehensive loss, and cash flows for the interim periods. These unaudited interim consolidated financial statements should be read in conjunction with the Company’s audited financial statements included in the Company’s Annual Report on Form 10-K, filed with the U.S Securities and Exchange Commission (SEC) on February 13, 2018 (the 2017 10-K). The Company's accounting policies are described in Note 1 to the audited financial statements included in the 2017 10-K. Operating results for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the full fiscal year or any other interim 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 amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from such estimates. See Note 1 to the audited financial statements included in the 2017 10-K for additional discussion of these estimates and assumptions.

Accumulated Other Comprehensive Loss

There were no reclassifications out of accumulated other comprehensive loss during the three months ended March 31, 2018 and 2017.

Income Taxes

On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act (Tax Act), making broad and complex changes to the Internal Revenue Code. The Company has made significant judgments and estimates in accordance with its interpretation of the Tax Act. As additional guidance on the Tax Act becomes available, the Company may adjust its interpretation of the requirements, which may result in a material change to income tax benefit or expense in the period in which the adjustment is made.

Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) amending the lease presentation guidance. The ASU requires organizations that lease assets to recognize the rights and obligations created by those leases on the consolidated balance sheets. This ASU is effective for fiscal years beginning after December 15, 2018 including interim periods within that reporting period, with early adoption permitted. The Company has determined this guidance will require recognition of a lease liability and corresponding asset on the consolidated balance sheets equal to the present value of minimum lease payments. The carrying amount of the asset is derived from the amount of the lease liability at the end of each reporting period. The Company plans to adopt this guidance as of January 1, 2019, and is in the process of evaluating the impact on its consolidated financial statements.

2. Net Loss per Share

Basic net loss per share is computed using the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is calculated using the weighted-average number of shares of common stock plus, when dilutive, potential common shares outstanding using the treasury-stock method. Potential common shares outstanding include stock options, unvested restricted stock awards and restricted stock units, and warrants.

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



	Three Months Ended March 31,
	2018	2017
Stock options	3,878,716	3,983,098
Restricted stock awards and restricted stock units	546,638	351,702
Warrants	510,000	810,000

3. Investment Securities

The amortized cost, gross unrealized holding gains and losses, fair value of long-term investments, which are classified as available-for-sale, and fair value of short-term investments by major security type and class of security were as follows as of March 31, 2018 and December 31, 2017 (in thousands):



	Amortized Cost		Gross Unrealized Holding Gains		Gross Unrealized Holding Losses			Fair Value
As of March 31, 2018
Available-for-sale:
Foreign deposits	$	2,253	$	—	$	—		$	2,253
Municipal bond	1,000		—		(15		)	985
	$	3,253	$	—	$	(15	)	$	3,238
Short-term investments:
U.S. Treasury securities	$	5,784	$	—	$	(2	)	$	5,782
Certificates of deposit	690		—		—			690
U.S. government funds	32,886		—		—			32,886
	$	39,360	$	—	$	(2	)	$	39,358

	Amortized Cost		Gross Unrealized Holding Gains		Gross Unrealized Holding Losses			Fair Value
As of December 31, 2017
Available-for-sale:
Foreign deposits	$	2,237	$	—	$	—		$	2,237
Municipal bond	1,000		—		—			1,000
	$	3,237	$	—	$	—		$	3,237
Short-term investments:
U.S. Treasury securities	$	5,783	$	—	$	(4	)	$	5,779
Certificates of deposit	690		1		—			691
U.S. government funds	31,117		—		—			31,117
	$	37,590	$	1	$	(4	)	$	37,587

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



	March 31, 2018
	Amortized Cost		Fair Value
Available-for-sale:
Due after one year through five years	$	2,253	$	2,253
Due after five years through ten years	1,000		985
	$	3,253	$	3,238

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

4. Fair Value

Investments

The following table summarizes, by major security type, the Company's assets that are measured at fair value on a recurring basis, and placement within the fair value hierarchy (in thousands):



	As of March 31, 2018
	Fair Value		Level 1		Level 2
Assets
Restricted cash	$	600	$	600	$	—
Foreign deposits	2,253		2,253		—
Municipal bond	985		—		985
Money market funds	7,717		7,717		—
Total	$	11,555	$	10,570	$	985

	As of December 31, 2017
	Fair Value		Level 1		Level 2
Assets
Restricted cash	$	600	$	600	$	—
Foreign deposits	2,237		2,237		—
Municipal bond	1,000		—		1,000
Money market funds	5,167		5,167		—
Total	$	9,004	$	8,004	$	1,000

The Company measures the fair value of restricted cash, foreign deposits, and money market funds based on quoted prices in active markets for identical assets. The fair value of the municipal bond is based on either recent trades in inactive markets or quoted market prices of similar instruments and other significant inputs derived from or corroborated by observable market data.

Fair Value Disclosures

As of March 31, 2018 and December 31, 2017, the Company's other long-term assets balance included a $2.5 million note receivable, recorded at its estimated collectible amount. The Company estimates that the carrying value of the note receivable approximates the fair value. The estimated fair value represents a Level 3 measurement within the fair value hierarchy, and is based on market interest rates and the assessed creditworthiness of the third party.

The Company estimates the fair value of 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 March 31, 2018 and December 31, 2017.

5. Debt

The Company has a revolving line of credit of up to $30.0 million, maturing December 2019. The facility is secured by any and all interests in the Company's assets that are not otherwise restricted. Interest on the revolving line of credit is payable monthly at the greater of 4.5%, or 1.25% plus the prime rate (6.00% at March 31, 2018). The credit agreement includes other ancillary services and letters of credit of up to $4.5 million, and requires a deposit of restricted cash of $0.6 million. As of March 31, 2018, the Company was in compliance with all financial and non-financial covenants required by the credit agreement.

Borrowings on the revolving line of credit are limited to the lesser of $30.0 million and the total amount of cash and securities held by the Company's insurance subsidiaries (American Pet Insurance Company and Wyndham Insurance Company (SAC) Limited Segregated Account AX). As of March 31, 2018, available borrowing capacity on the line of credit was $13.0 million, with an outstanding balance of $2.0 million for ancillary services and letters of credit, and borrowings under the facility were $15.0 million, recorded net of financing fees of $0.1 million.

6. Commitments and Contingencies

From time to time, the Company is subject to litigation matters and claims arising from the ordinary course of business. The Company records a provision for a liability relating to legal matters when it is both probable that a material liability has been incurred and the amount of the loss can be reasonably estimated. At this time, the Company does not believe any such matters to be material individually or in the aggregate. These views are subject to change following the outcome of future events or the results of future developments.

7. Reserve for Veterinary Invoices

The reserve for veterinary invoices is an estimate of the future amount the Company will pay for veterinary invoices that are dated as of, or prior to, its balance sheet date. The reserve also includes the Company's estimate of related internal processing costs. The reserve estimate involves actuarial projections, and is based on management's assessment of facts and circumstances currently known, and assumptions about anticipated patterns, including expected future trends in the number of veterinary invoices the Company will receive and the average cost of those veterinary invoices. The reserve is made for each of the Company's segments, subscription and other business, and are continually refined as the Company receives and pays veterinary invoices. Changes in management's assumptions and estimates may have a relatively large impact to the reserve and associated expense.

Reserve for veterinary invoices

Summarized below are the changes in the total liability for the Company's subscription business segment (in thousands):



	Three Months Ended March 31,
Subscription	2018			2017
Reserve at beginning of year	$	11,059		$	8,538
Veterinary invoices during the period related to:
Current year	45,198			36,518
Prior years	(61		)	(195		)
Total veterinary invoice expense	45,137			36,323
Amounts paid during the period related to:
Current year	36,142			28,868
Prior years	8,250			6,400
Total paid	44,392			35,268
Non-cash expenses	156			93
Reserve at end of period	$	11,648		$	9,500

The Company's reserve for the subscription business segment increased from $11.1 million at December 31, 2017 to $11.6 million at March 31, 2018. This change was comprised of $45.1 million in expense recorded during the period less $44.4 million in payments of veterinary invoices. The $45.1 million in veterinary invoice expense incurred includes a reduction of $0.1 million to the reserves relating to prior years, which is the result of ongoing analysis of recent payment trends. For the three months ended March 31, 2017, the Company decreased prior year reserves by $0.2 million as a result of analysis of payment trends.

Summarized below are the changes in total liability for the Company's other business segment (in thousands):



	Three Months Ended March 31,
Other Business	2018			2017
Reserve at beginning of year	$	1,697		$	983
Veterinary invoices during the period related to:
Current year	5,218			3,048
Prior years	(242		)	(184		)
Total veterinary invoice expense	4,976			2,864
Amounts paid during the period related to:
Current year	3,734			2,092
Prior years	1,137			634
Total paid	4,871			2,726
Non-cash expenses	—			—
Reserve at end of period	$	1,802		$	1,121

The Company’s reserve for the other business segment increased from $1.7 million at December 31, 2017 to $1.8 million at March 31, 2018. This change was comprised of $5.0 million in expense recorded during the period less $4.9 million in payments of veterinary invoices. The $5.0 million in veterinary invoice expense incurred includes a reduction of $0.2 million to the reserves relating to prior years, which is the result of ongoing analysis of recent payment trends. For the three months ended March 31, 2017, the Company decreased prior year reserves by $0.2 million as a result of analysis of payment trends.

Reserve for veterinary invoices, by year of occurrence

In the following tables, the reserve for veterinary invoices for each segment is presented as the amount (in thousands) by year the veterinary invoice relates to, referred to as the year of occurrence.



Subscription	As of March 31, 2018
Year of Occurrence
2016	$	453
2017	2,295
2018	8,900
	$	11,648



Other Business	As of March 31, 2018
Year of Occurrence
2017	317
2018	1,485
	$	1,802

8. Stock-Based Compensation and Stockholders' Equity

Stock-based Compensation

Stock-based compensation expense includes stock options, restricted stock awards, and restricted stock units granted to employees and non-employees and has been reported in the Company’s consolidated statements of operations depending on the function performed by the employee or non-employee. Stock-based compensation expense recognized in the consolidated statements of operations was as follows (in thousands):



	Three Months Ended March 31,
	2018		2017
Veterinary invoice expense	$	120	$	70
Other cost of revenue	77		43
Technology and development	49		50
General and administrative	449		431
Sales and marketing	273		187
Total stock-based compensation	$	968	$	781

As of March 31, 2018, for all employees, the Company had 896,125 unvested stock options and 546,683 unvested restricted stock awards and restricted stock units that are expected to vest. Stock-based compensation expense of $5.0 million related to unvested stock options and $8.8 million related to unvested restricted stock awards and restricted stock units, each expected to be recognized over a weighted-average period of approximately 2.5 years.

Stock Options

A summary of the Company's stock option activity is as follows:



	Number Of Options		Weighted-Average Exercise Price per Share		Aggregate Intrinsic Value (in thousands)
Outstanding as of December 31, 2017	4,006,399		$	7.16	$	88,578
Granted	—		—
Exercised	(101,514	)	4.74		2,605
Forfeited	(26,169	)	15.75
Outstanding as of March 31, 2018	3,878,716		7.17		88,138

Exercisable as of March 31, 2018	2,977,257		$	4.67	$	75,089

As of March 31, 2018, stock options outstanding and stock options exercisable had a weighted average remaining contractual life of 5.1 years and 4.1 years, respectively.

Restricted Stock Awards and Restricted Stock Units

A summary of the Company’s restricted stock award and restricted stock unit activity is as follows:



	Number of Shares		Weighted Average Grant Date Fair Value per Share
Unvested shares as of December 31, 2017	256,842		4.77
Granted	296,749		27.99
Vested	(6,590	)	27.04
Forfeited	(318	)	28.01
Unvested shares as of March 31, 2018	546,683		18.16

Stockholders’ Equity

In February 2018, 300,000 of the Company's outstanding warrants were exercised. As of March 31, 2018, warrants to purchase 510,000 shares of the Company's common stock at $10.00 per share remained outstanding. The warrants automatically convert to common stock in 2019.

9. Segments

The Company has two segments: subscription business and other business. The subscription business segment includes monthly subscription fees related to the Company’s medical insurance which is marketed directly to consumers, while the other business segment includes all other business that is not directly marketed to consumers.

The chief operating decision maker uses two measures to evaluate segment performance: revenue and gross profit. Additionally, other operating expenses, such as sales and marketing expenses, are allocated to each segment and evaluated when material. Interest and other expenses and income taxes are not allocated to the segments, nor included in the measure of segment profit or loss. The Company does not analyze discrete segment balance sheet information related to long-term assets.

Revenue and gross profit of the Company’s segments were as follows (in thousands):



	Three Months Ended March 31,
	2018			2017
Revenue:
Subscription business	$	61,517		$	50,229
Other business	8,243			4,500
	69,760			54,729
Veterinary invoice expense:
Subscription business	45,137			36,323
Other business	4,976			2,864
	50,113			39,187
Other cost of revenue:
Subscription business	5,877			4,923
Other business	2,706			1,464
	8,583			6,387
Gross profit:
Subscription business	10,503			8,983
Other business	561			172
	11,064			9,155

Technology and development	2,164			2,403
General and administrative	4,458			4,012
Sales and marketing:
Subscription business	5,851			4,041
Other business	87			48
	5,938			4,089
Operating loss	$	(1,496	)	$	(1,349	)

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



	Three Months Ended March 31,
	2018		2017
United States	$	56,009	$	44,134
Canada	13,751		10,595
Total revenue	$	69,760	$	54,729

Substantially all of the Company’s long-lived assets were located in the United States as of March 31, 2018 and December 31, 2017.

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

Overview

We provide medical insurance for cats and dogs throughout the United States, Canada and Puerto Rico. Our data-driven, vertically-integrated approach enables us to provide pet owners with what we believe is the highest value medical insurance for their pets, priced specifically for each pet’s unique characteristics. Our growing and loyal member base provides us with highly predictable and recurring revenue. We operate our business similar to other subscription-based businesses, with a focus on maximizing the lifetime value of each pet while sustaining a favorable ratio of lifetime value relative to pet acquisition cost, based on our desired return on investment.

We operate in two business segments: subscription business and other business. We generate revenue in our subscription business segment primarily from subscription fees for our medical insurance, which we market to consumers. Fees are paid at the beginning of each subscription period, which automatically renews on a monthly basis. We generate revenue in our other business segment writing policies on behalf of third parties, where we do not undertake the marketing, and have more of a business-to-business relationship. Our other business segment consists of companies or organizations that choose to provide medical insurance for cats and dogs as a benefit to their employees or members, and contracts include multiple pets. The policies in our other business segment may be materially different from our subscription business. Our ultimate goal is to build the Trupanion brand by continuing to offer the highest value proposition in the industry and maintain strong alignment with the veterinary community. We believe our activities in our other business segment benefit the overall market for pet medical insurance by expanding upon product options and distribution models within other market niches.

We generate leads for our subscription business through both third-party referrals and direct-to-consumer acquisition channels, which we then convert into members through our website and contact center. Veterinary practices represent our largest referral source. We engage a national referral group of Territory Partners. These independent contractors are dedicated to cultivating direct veterinary relationships and building awareness of the benefits of our subscription to veterinarians and their clients. Veterinarians then educate pet owners, who visit our website or call our contact center to learn more about, and potentially enroll in, Trupanion. We pay Territory Partners fees based on activity in their regions. We also receive a significant number of new leads from existing members adding pets and referring their friends and family members. Our direct-to-consumer acquisition channels serve as important resources for pet owner education and drive new member leads and conversion. We continuously evaluate the effectiveness of our member acquisition channels and marketing initiatives based upon their return on investment, which we measure by comparing the ratio of the lifetime value of a pet generated through each specific channel or initiative to the related acquisition cost.

Key Operating Metrics

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



	Period Ended
	Mar. 31, 2018			Dec. 31, 2017			Sept. 30, 2017			Jun. 30, 2017			Mar. 31, 2017			Dec. 31, 2016			Sept. 30, 2016			Jun. 30, 2016
Total subscription pets enrolled (at period end)	385,640			371,683			359,102			346,409			334,909			323,233			312,282			299,856
Total pets enrolled (at period end)	446,533			423,194			404,069			383,293			364,259			343,649			334,070			320,896
Monthly average revenue per pet	$	53.62		$	53.17		$	52.95		$	51.47		$	50.50		$	49.17		$	48.37		$	47.39
Lifetime value of a pet (LVP)	$	727		$	727		$	701		$	654		$	637		$	631		$	624		$	622
Average pet acquisition cost (PAC)	$	165		$	184		$	151		$	143		$	128		$	133		$	120		$	118
Average monthly retention	98.63		%	98.63		%	98.61		%	98.57		%	98.58		%	98.60		%	98.61		%	98.64		%

Total subscription pets enrolled. Total subscription pets enrolled reflects the number of pets in active memberships at the end of each period presented. We monitor total subscription pets enrolled because it provides an indication of the growth of our subscription business.

Total pets enrolled. Total pets enrolled reflects the number of subscription pets or pets enrolled in one of the insurance products offered in our other business segment at the end of each period presented. We monitor total pets enrolled because it provides an indication of the growth of our consolidated business.

Monthly average revenue per pet. Monthly average revenue per pet is calculated as amounts billed in a given month for subscriptions divided by the total number of subscription pet months in the period. Total subscription pet months in a period represents the sum of all pets enrolled for each month during the period. We monitor monthly average revenue per pet because it is an indicator of the per pet unit economics of our business.

Lifetime value of a pet. Lifetime value of a pet (LVP) is a business operating metric that we believe reflects the lifetime value we might expect from a new pet enrollment. We calculate LVP 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.

Average pet acquisition cost. Average pet acquisition cost (PAC) is calculated as net acquisition cost divided by the total number of new subscription pets enrolled in that period. Net acquisition cost, a non-GAAP financial measure, is calculated in a reporting period as sales and marketing expense, excluding stock-based compensation expense and other business segment sales and marketing expense, offset by sign-up fee revenue. We exclude stock-based compensation expense because the amount varies from period to period based on number of awards issued and market-based valuation inputs. We offset sign-up fee revenue because it is a one-time charge to new members collected at the time of enrollment used to partially offset initial setup costs, which are included in sales and marketing expenses. We exclude other business segment sales and marketing expense because that does not relate to subscription enrollments. We monitor average pet acquisition cost to evaluate the efficiency of our sales and marketing programs in acquiring new members and measure effectiveness using the ratio of our lifetime value of a pet to average pet acquisition cost, based on our desired return on investment.

Average monthly retention. Average monthly retention is measured as the monthly retention rate of enrolled subscription pets for each applicable period averaged over the 12 months prior to the period end date. As such, our average monthly retention rate as of March 31, 2018 is an average of each month’s retention from April 1, 2017 through March 31, 2018. We calculate monthly retention as the number of pets that remain after subtracting all pets that cancel during a month, including pets that enroll and cancel within that month, divided by the total pets enrolled at the beginning of that month. We monitor average monthly retention because it provides a measure of member satisfaction and allows us to calculate the implied average subscriber life in months.

Non-GAAP Financial Measures

We believe that using net acquisition cost to calculate and present certain of our other key metrics is helpful to our investors and an important tool for financial and operational decision-making and evaluating our operating results over different periods of time. Measuring net acquisition cost by removing stock-based compensation expense and other business segment sales and marketing expense offset by sign-up fee revenue provides for a more comparable metric across periods.

This measure, which is a non-GAAP financial measure, may not provide information that is directly comparable to that provided by other companies in our industry. In addition, this measure excludes stock-based compensation expense, which has been, and is expected to continue to be for the foreseeable future, a significant recurring component of our sales and marketing expense. The presentation and utilization of non-GAAP financial measures is not meant to be considered in isolation or as a substitute for the directly comparable financial measures prepared in accordance with GAAP.

The following table reflects the reconciliation of net acquisition cost to sales and marketing expense (in thousands):



	Period Ended
	Mar. 31, 2018			Dec. 31, 2017			Sept. 30, 2017			Jun. 30, 2017			Mar. 31, 2017			Dec. 31, 2016			Sept. 30, 2016			Jun. 30, 2016
Sales and marketing expense	$	5,938		$	5,781		$	4,862		$	4,372		$	4,089		$	3,951		$	3,892		$	3,564
Net of sign-up fee revenue	(616		)	(550		)	(558		)	(517		)	(544		)	(526		)	(525		)	(495		)
Excluding:
Stock-based compensation expense	(273		)	(172		)	(165		)	(198		)	(187		)	(113		)	(172		)	(165		)
Other business segment sales and marketing expense	(87		)	(56		)	(51		)	(63		)	(48		)	(62		)	(63		)	(55		)
Net acquisition cost	$	4,962		$	5,003		$	4,088		$	3,594		$	3,310		$	3,250		$	3,132		$	2,849

Components of Operating Results

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

Revenue

We generate revenue in our subscription business segment primarily from subscription fees for our pet medical insurance. Fees are paid at the beginning of each subscription period, which automatically renews on a monthly basis. In most cases, our members authorize us to directly charge their credit card, debit card or bank account through automatic funds transfer. Subscription revenue is recognized on a pro rata basis over the monthly enrollment term. Membership may be canceled at any time without penalty, and we issue a refund for the unused portion of the canceled membership.

We generate revenue in our other business segment primarily from writing policies on behalf of third parties where we do not undertake the direct consumer marketing. This segment includes the writing of policies that may be materially different from our subscription.

Cost of Revenue

Cost of revenue in each of our segments is comprised of the following:

Veterinary invoice expense

Veterinary invoice expense includes our costs to review veterinary invoices, administer the payments, and provide member services, and other operating expenses directly or indirectly related to this process. We also accrue for veterinary invoices that have been incurred but not yet received. This also includes amounts paid by unaffiliated general agents, and an estimate of amounts incurred and not yet paid for our other business segment.

Other cost of revenue

Other cost of revenue for the subscription business segment includes direct and indirect member service expenses, Territory Partner renewal fees, credit card transaction fees and premium tax expenses. Other cost of revenue for the other business segment includes the commissions we pay to unaffiliated general agents, costs to administer the programs in the other business segment and premium taxes on the sales in this segment.

Operating Expenses

Our operating expenses are classified into three categories: technology and development, general and administrative, and sales and marketing. For each category, the largest component is personnel costs, which include salaries, employee benefit costs, bonuses and stock-based compensation expense.

Technology and Development

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

General and Administrative

General and administrative expenses consist primarily of personnel costs and related expenses for our finance, actuarial, human resources, regulatory, legal and general management functions, as well as facilities and professional services.

Sales and Marketing

Sales and marketing expenses primarily consist of the cost to educate veterinarians and consumers about the benefits of Trupanion, to generate leads and to convert leads into enrolled pets, as well as print, online and promotional advertising costs, and employee compensation and related costs. Sales and marketing expenses are driven primarily by investments to acquire new members.

Factors Affecting Our Performance

Average monthly retention. Our performance depends on our ability to continue to retain our existing and newly enrolled pets and is impacted by our ability to provide a best-in-class value and member experience. Our ability to retain enrolled pets depends on a number of factors, including the actual and perceived value of our services and the quality of our member experience, the ease and transparency of the process for reviewing and paying veterinary invoices for our members, and the competitive environment. In addition, other initiatives across our business may temporarily impact retention and make it difficult for us to improve or maintain this metric. For example, if the number of new pets enrolled increases at a faster rate than our historical experience, our average monthly retention rate could be adversely impacted, as our retention rate is generally lower during the first year of member enrollment.

Investment in pet acquisition. We have made and plan to continue to make significant investments to grow our member base. Our net acquisition cost and the number of new members we enroll depends on a number of factors, including the amount we elect to invest in sales and marketing activities in any particular period in the aggregate and by channel, the frequency of existing members adding a pet or referring their friends or family, effectiveness of our sales execution and marketing initiatives, changes in costs of media, the mix of our sales and marketing expenditures and the competitive environment. Our average pet acquisition cost has in the past significantly varied, and in the future may significantly vary, from period to period based upon specific marketing initiatives and the actual or expected relationship to LVP and estimated rates of return on pet acquisition spend. We also regularly test new member acquisition channels and marketing initiatives, which may be more expensive than our traditional marketing channels and may increase our average acquisition costs. We continually assess our sales and marketing activities by monitoring the ratio of LVP to PAC and the return on PAC spend both on a detailed level by acquisition channel and in the aggregate.

Timing of initiatives. Over time we plan to implement new initiatives to improve our member experience, make modifications to our subscription plan and find other ways to maintain a strong value proposition for our members. These initiatives will sometimes be accompanied by price adjustments, in order to compensate for an increase in benefits received by our members. The implementation of such initiatives may not always coincide with the timing of price adjustments, resulting in fluctuations in revenue and gross profit in our subscription business segment.

Geographic mix of sales. The relative mix of our business between the United States and Canada impacts the monthly average revenue per pet we receive. Prices for our plan in Canada are generally higher than in the United States (in local currencies), which is consistent with the relative cost of veterinary care in each country. As our revenue has grown faster in the United States compared to Canada, this geographic shift in the mix of business has reduced the growth in our monthly average revenue per pet. In addition, as our mix of revenue changes between the United States and Canada, our exposure to foreign exchange fluctuations will be impacted.

Other business segment. Our other business segment primarily includes revenue and expenses related to policies written on behalf of third parties. This segment includes the writing of policies that may be materially different from our subscription. Our relationships in our other business segment are generally subject to termination provisions and are non-exclusive. Accordingly, we cannot control the volume of business, even if a contract is not terminated. Loss of an entire program via contract termination could result in the associated policies and revenues being lost over a period of 12 to 18 months, which could have a material impact on our results of operations. We may enter into additional relationships in the future to the extent we believe they will be profitable to us, which could also impact our operating results.

Results of Operations

The following tables set forth our results of operations for the periods presented both in absolute dollars and as a percentage of total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results.



	Three Months Ended March 31,
	2018			2017
	(in thousands)
Revenue:
Subscription business	$	61,517		$	50,229
Other business	8,243			4,500
Total revenue	69,760			54,729
Cost of revenue:
Subscription business⁽¹⁾	51,014			41,246
Other business	7,682			4,328
Total cost of revenue	58,696			45,574
Gross profit:
Subscription business	10,503			8,983
Other business	561			172
Total gross profit	11,064			9,155
Operating expenses:
Technology and development⁽¹⁾	2,164			2,403
General and administrative⁽¹⁾	4,458			4,012
Sales and marketing⁽¹⁾	5,938			4,089
Total operating expenses	12,560			10,504
Operating loss	(1,496		)	(1,349		)
Interest expense	219			137
Other (income) expense, net	(140		)	(28		)
Loss before income taxes	(1,575		)	(1,458		)
Income tax (benefit) expense	(95		)	24
Net loss	$	(1,480	)	$	(1,482	)




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



	Three Months Ended March 31,
	2018		2017
	(in thousands)
Cost of revenue	$	197	$	113
Technology and development	49		50
General and administrative	449		431
Sales and marketing	273		187
Total stock-based compensation expense	$	968	$	781



	Three Months Ended March 31,
	2018		2017
	(as a percentage of revenue)
Revenue	100	%	100	%
Cost of revenue	84		83
Gross profit	16		17
Operating expenses:
Technology and development	3		4
General and administrative	6		7
Sales and marketing	9		7
Total operating expenses	18		19
Operating loss	(2	)	(2	)
Loss before income taxes	(2	)	(3	)
Net loss	(2	)%	(3	)%



	Three Months Ended March 31,
	2018		2017
	(as a percentage of subscription revenue)
Subscription business revenue	100	%	100	%
Subscription business cost of revenue	83		82
Subscription business gross profit	17	%	18	%

Comparison of the Three Months Ended March 31, 2018 and 2017

Revenue



	Three Months Ended March 31,						% Change
	2018			2017			% Change
	(in thousands, except percentages, pet and per pet data)
Revenue:
Subscription business	$	61,517		$	50,229		22	%
Other business	8,243			4,500			83
Total revenue	$	69,760		$	54,729		27

Percentage of Revenue by Segment:
Subscription business	88		%	92		%
Other business	12			8
Total revenue	100		%	100		%

Total subscription pets enrolled (at period end)	385,640			334,909			15
Total pets enrolled (at period end)	446,533			364,259			23
Monthly average revenue per pet	$	53.62		$	50.50		6
Average monthly retention	98.63		%	98.58		%

Three months ended March 31, 2018 compared to three months ended March 31, 2017. Total revenue increased by $15.0 million to $69.8 million for the three months ended March 31, 2018, or 27%. Revenue from our subscription business segment increased by $11.3 million to $61.5 million for the three months ended March 31, 2018, or 22%. This increase in subscription business revenue was primarily due to a 15% increase in total subscription pets enrolled as of March 31, 2018 compared to March 31, 2017, and an increase in average revenue per pet of 6% for the same period. Increases in pricing were primarily due to the increased cost of veterinary care and more accurately pricing to our cost-plus margin structure by subcategory. Revenue from our other business segment increased $3.7 million to $8.2 million for the three months ended March 31, 2018, or 83%, primarily due to an increase in enrolled pets in this segment.

Cost of Revenue



	Three Months Ended March 31,						% Change
	2018			2017			% Change
	(in thousands, except percentages, pet and per pet data)
Cost of Revenue:
Subscription business:
Veterinary invoice expense	$	45,137		$	36,323		24	%
Other cost of revenue	5,877			4,923			19
Total cost of revenue	51,014			41,246			24
Gross profit	10,503			8,983			17
Other business:
Veterinary invoice expense	4,976			2,864			74
Other cost of revenue	2,706			1,464			85
Total cost of revenue	7,682			4,328			77
Gross profit	561			172			226

Percentage of Revenue by Segment:
Subscription business:
Veterinary invoice expense	73		%	72		%
Other cost of revenue	10			10
Total cost of revenue	83			82
Gross profit	17			18
Other business:
Veterinary invoice expense	60			64
Other cost of revenue	33			33
Total cost of revenue	93			96
Gross profit	7			4

Total subscription pets enrolled (at period end)	385,640			334,909			15
Total pets enrolled (at period end)	446,533			364,259			23
Monthly average revenue per pet	$	53.62		$	50.50		6

Three months ended March 31, 2018 compared to three months ended March 31, 2017. Cost of revenue for our subscription business segment was $51.0 million, or 83% of revenue, for the three months ended March 31, 2018, compared to $41.2 million, or 82% of revenue, for the three months ended March 31, 2017. This $9.8 million increase in subscription cost of revenue was primarily the result of a 15% increase in subscription pets enrolled, resulting in a 24% increase in veterinary invoice expense and related internal processing costs. As a percentage of revenue, these costs increased to 73% for the three months ended March 31, 2018 from 72% for the three months ended March 31, 2017, primarily due to an increase in the volume of veterinary invoices received and the resulting increase in the costs to process and pay the invoices. Cost of revenue for our other business segment increased $3.4 million to $7.7 million for the three months ended March 31, 2018, primarily due to an increase in enrolled pets in this segment.

Technology and Development Expenses



	Three Months Ended March 31,						% Change
	2018			2017			% Change
	(in thousands, except percentages)
Technology and development	$	2,164		$	2,403		(10	)%
Percentage of total revenue	3		%	4		%

Three months ended March 31, 2018 compared to three months ended March 31, 2017. Technology and development expenses decreased $0.2 million, or 10%, to $2.2 million for the three months ended March 31, 2018. This was primarily due to having more resources dedicated to capital projects, resulting in a higher proportion of costs being capitalized than in the prior year.

General and Administrative Expenses



	Three Months Ended March 31,						% Change
	2018			2017			% Change
	(in thousands, except percentages)
General and administrative	$	4,458		$	4,012		11	%
Percentage of total revenue	6		%	7		%

Three months ended March 31, 2018 compared to three months ended March 31, 2017. General and administrative expenses increased $0.4 million, or 11%, to $4.5 million for the three months ended March 31, 2018. This was primarily due to higher occupancy costs and increased headcount. General and administrative expenses decreased from 7% to 6% as a percentage of revenue for the three months ended March 31, 2018, as we experienced scale in our support functions.

Sales and Marketing Expenses



	Three Months Ended March 31,				% Change
	2018		2017		% Change
	(in thousands, except percentages, pet and per pet data)
Sales and marketing	$	5,938	$	4,089	45	%
Subscription Business:
Total subscription pets enrolled (at period end)	385,640		334,909		15
Average pet acquisition cost (PAC)	$	165	$	128	29

Three months ended March 31, 2018 compared to three months ended March 31, 2017. Sales and marketing expense increased $1.8 million, or 45%, to $5.9 million for the three months ended March 31, 2018. PAC increased 29% from March 31, 2017, to $165 for the three months ended March 31, 2018, as a result of $0.5 million in additional testing of new marketing initiatives and an increase of $1.0 million in compensation expenses due to an 18% increase in headcount, primarily related to our inside sales team.

Total Other Expense, Net



	Three Months Ended March 31,
	2018			2017
	(in thousands)
Interest expense	$	219		$	137
Other (income) expense, net	(140		)	(28		)
Total other expense, net	$	79		$	109

Three months ended March 31, 2018 compared to three months ended March 31, 2017. Total other expense, net remained comparable at $0.1 million.

Liquidity and Capital Resources

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



	Three Months Ended March 31,
	2018			2017
Net cash provided by operating activities	$	2,077		$	1,857
Net cash used in investing activities	(2,832		)	(4,473		)
Net cash provided by financing activities	5,765			895
Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash, net	70			21
Net change in cash, cash equivalents and restricted cash	$	5,080		$	(1,700	)

Our primary sources of liquidity are cash provided by operations and available borrowings on our line of credit. Our primary requirements for liquidity are paying veterinary invoices, funding operations and capital requirements, investing in new member acquisition, investing in enhancements to our member experience, and servicing debt.

As of March 31, 2018, we had $70.1 million in cash, cash equivalents and short-term investments and $13.0 million available under our line of credit, which excludes $2.0 million reserved under the credit agreement for an outstanding letter of credit and other ancillary services. Most of the assets in our insurance subsidiary, American Pet Insurance Company (APIC), and our segregated cell business, Wyndham Insurance Company (SAC) Limited (WICL) Segregated Account AX, are subject to certain capital and dividend rules and regulations prescribed by jurisdictions in which they are authorized to operate. As of March 31, 2018, total assets and liabilities held outside of our insurance entities totaled $48.8 million and $27.6 million, respectively, including $19.7 million of cash and cash equivalents that are segregated from other operating funds and held in trust for the payment of claims on behalf of our insurance subsidiaries. For further information, refer to "Regulation."

We believe our cash and cash equivalents, short-term investments and line of credit are sufficient to fund our operations and capital requirements for the next 12 months. As we continue to grow, however, we may explore additional financing to fund our operations or to meet capital requirements. Financing could include equity, equity-linked, or debt financing. Additional financing may not be available to us on acceptable terms, or at all.

Operating Cash Flows

We derive operating cash flows from the sale of our subscription plans, which is used to pay veterinary invoices and other cost of revenue. Additionally, cash is used to support the growth of our business by reinvesting to acquire new pet enrollments and to fund projects that improve our members' experience. Cash provided by operating activities was $2.1 million for the three months ended March 31, 2018 compared to cash provided by operating activities of $1.9 million for the three months ended March 31, 2017. The increase in cash provided by operating activities of $0.2 million was primarily related to timing differences between collections from members and payments of veterinary invoices and payments to vendors.

Investing Cash Flows

Net cash used in investing activities for each of the periods presented was primarily related to the net purchase of investments to increase our statutory capital. As of March 31, 2018, we had $42.6 million in short-term and long-term investments in our insurance entities, APIC and WICL Segregated Account AX. These investments are held to satisfy statutory requirements. Our regulators may increase the required levels of risk-based capital in the future, and we anticipate that we will need to maintain greater amounts of risk-based capital if our pet enrollment continues to grow.

Financing Cash Flows

Cash provided by financing activities was $5.8 million and $0.9 million for the three months ended March 31, 2018 and 2017, respectively. The increase of $4.9 million was primarily due to additional borrowings of $5.5 million on our line of credit, offset by reduced proceeds from option exercises as compared to the prior year.

Long-Term Debt

Pacific Western Bank Loan and Security Agreement

The Company has a syndicated loan agreement with Pacific Western Bank (PWB) and Western Alliance Bank (WAB) of up to $30.0 million, maturing December 2019. We refer to this line of credit as our PWB credit facility. The maximum amount available to us under the PWB credit facility, inclusive of any amounts outstanding under the revolving line of credit, is the lesser of $30.0 million or the total amount of cash and securities held by our insurance entities, less $2.0 million for obligations we have outstanding from PWB and/or WAB for other ancillary services and our letter of credit. Interest on the PWB credit facility accrues at a variable annual rate equal to the greater of 4.5%, or 1.25% plus the prime rate (6.00% at March 31, 2018).

The PWB credit facility requires us to maintain certain financial and non-financial covenants, including maintaining a minimum cash balance of $0.6 million in our account at WAB and/or WAB affiliates and other cash or investments of $1.4 million in our accounts at PWB. As of March 31, 2018, we were in compliance with each of the financial and non-financial covenants.

Our obligations under the PWB credit facility are secured by substantially all of our assets and a pledge of certain of our subsidiaries’ stock. As of March 31, 2018, we had $15.0 million in aggregate borrowings outstanding under the PWB credit facility.

Regulation

As of March 31, 2018, our insurance entities, APIC and WICL Segregated Account AX, held $39.3 million in short-term investments and $25.8 million in other current assets, including $3.7 million held in cash and cash equivalents to be used for operating expenses of our insurance subsidiaries. Most of the assets in APIC and WICL Segregated Account AX are subject to certain capital and dividend rules and regulations prescribed by jurisdictions in which they are authorized to operate.

To comply with the regulations and contractual obligations of APIC and WICL Segregated Account AX, we may be required to maintain capital that we would otherwise invest in our growth and operations, which may require us to modify our operating plan or marketing initiatives, delay the implementation of new solutions or development of new technologies, decrease the rate at which we hire additional personnel and enter into relationships with Territory Partners, incur indebtedness or pursue equity or debt financings or otherwise modify our business operations.

APIC

The majority of our investments are held by our insurance entities to satisfy risk-based capital requirements of the National Association of Insurance Commissioners (NAIC). The NAIC requirements provide a method for analyzing the minimum amount of risk-based capital (statutory capital and surplus plus other adjustments) appropriate for an insurance company to support its overall business operations, taking into account the risk characteristics of the company’s assets, liabilities and certain other items. An insurance company found to have insufficient statutory capital based on its risk-based capital ratio may be subject to varying levels of additional regulatory oversight depending on the level of capital inadequacy. APIC must hold certain capital amounts in order to comply with the statutory regulations and, therefore, we cannot use these amounts for general operating purposes without regulatory approval. As our business grows, the amount of capital we are required to maintain to satisfy our risk-based capital requirements may increase significantly. As of December 31, 2017, APIC was required to maintain at least $22.2 million of risk-based capital to avoid this additional regulatory oversight. As of that date, APIC maintained $37.2 million of risk-based capital. The New York Department of Financial Services may increase the required levels of risk-based capital in the future, and we anticipate that we will need to maintain greater amounts of risk-based capital if our pet enrollment continues to grow.

New York laws also restrict the ability of APIC to pay dividends to our parent holding company. The dividend restrictions are based in part on the prior year’s statutory income and surplus. Dividends up to specified levels are considered ordinary and may be paid without prior approval. In general, dividends or distributions that, in the aggregate in any 12-month period exceed the lesser of (i) 10% of surplus as of the preceding December 31 or (ii) the insurer’s adjusted net investment income for such 12-month period ended the preceding December 31, not including realized capital gains, are subject to approval by regulatory authorities. As of December 31, 2017, less than $0.2 million was able to be paid in the form of a dividend from APIC to our parent holding company without prior approval from regulatory authorities.

WICL Segregated Account AX

WICL Segregated Account AX was established by WICL, with Trupanion, Inc. as the shareholder, to enter into a reinsurance agreement with Omega General Insurance Company. All of the assets and liabilities of WICL Segregated Account AX are legally segregated from other assets and liabilities within WICL, and all shares of the segregated account are owned by Trupanion, Inc. During February 2018, our parent entity received a dividend of $2.2 million from WICL Segregated Account AX as allowed under our agreements with WICL. As required by the Office of the Superintendent of Financial Institutions regulations related to our reinsurance agreement with Omega General Insurance Company, we are required to maintain a Canadian Trust account with the greater of CAD $2.0 million or 115% of unearned Canadian premium plus 15% of outstanding Canadian claims, including all incurred but not reported claims. As of December 31, 2017, the account held CAD $2.8 million.

Though we are not directly regulated by the Bermuda Monetary Authority (BMA), WICL's regulation and compliance impacts us as it could have an adverse impact on the ability of WICL Segregated Account AX to pay dividends. WICL is regulated by the BMA under the Insurance Act of 1978 (Insurance Act) and the Segregated Accounts Company Act of 2000. The Insurance Act imposes on Bermuda insurance companies, solvency and liquidity standards, certain restrictions on the declaration and payment of dividends and distributions, certain restrictions on the reduction of statutory capital, and auditing and reporting requirements, and grants the BMA powers to supervise and, in certain circumstances, to investigate and intervene in the affairs of insurance companies. Under the Insurance Act, WICL, as a class 3 insurer, is required to maintain available statutory capital and surplus at a level equal to or in excess of a prescribed minimum established by reference to net written premiums and loss reserves.

Under the Bermuda Companies Act 1981, as amended, a Bermuda company may not declare or pay a dividend or make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would after the payment be, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than its liabilities. The Segregated Accounts Company Act of 2000 further requires that dividends out of a segregated account can only be paid to the extent that the cell remains solvent and the value of its assets remain greater than the aggregate of its liabilities and its issued share capital and share premium accounts.

Contractual Obligations

We enter into long-term contractual obligations and commitments in the normal course of business, primarily debt obligations and non-cancellable operating leases. Management believes there have been no material changes to our contractual obligation disclosure during the three months ended March 31, 2018, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

Critical Accounting Policies and Significant Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements, as well as the reported revenue and expenses during the reporting periods.

Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Generally, we base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances. Actual results may differ from these estimates.

There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

Management believes there have been no material changes to our quantitative and qualitative disclosures about market risks during the three months ended March 31, 2018, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control

There were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, the Company is subject to litigation matters and claims arising from the ordinary course of business, including, but not limited to, claims of alleged infringement of trademarks, copyrights, and other intellectual property rights; employment claims; coverage disputes with policyholders; disputes regarding general contracts; and regulatory or governmental investigations or disputes. The Company records an estimated liability relating to such matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The outcomes of legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to the Company's operating results for a particular period. The Company reviews its estimates at least quarterly and makes adjustments to reflect the outcome of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter.

Item 1A. Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this report, including our consolidated financial statements and related notes, as well as in our other filings with the SEC, in evaluating our business and before investing in our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that are not expressly stated, that we are unaware of, or that we currently believe are not material, may also become important factors that affect us. If any of the following risks occur, our business, operating results, financial condition and prospects could be materially harmed. In that event, the price of our common stock could decline, and you could lose part or all of your investment.

Risks Related to Our Business and Industry

We have incurred significant net losses since our inception and may not be able to achieve or maintain profitability in the future.

We have incurred significant net losses since our inception. We have funded our operations through equity financings, borrowings under a revolving line of credit and term loans and, more recently, positive cash flows from operations. We may not be able to achieve or maintain profitability in the near future or at all. Our recent growth, including our growth in revenue and membership, may not be sustainable or may decrease, and we may not generate sufficient revenue to achieve or maintain profitability. Additionally, our expense levels are based, in significant part, on our estimates of future revenue and many of these expenses are fixed in the short term. As a result, we may be unable to adjust our spending in a timely manner if our revenue falls short of our expectations. Accordingly, any significant shortfall of revenue in relation to our estimates could have an immediate negative effect on our financial results.

We have made and plan to continue to make significant investments to grow our member base. Our average pet acquisition cost and the number of new pets we enroll depends on a number of factors, including the 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 period to period based upon specific marketing initiatives. We also regularly test new member acquisition channels and marketing initiatives, which often are more expensive than our traditional marketing channels and generally increase our average acquisition costs. We plan to expand the number of Territory Partners we use to reach veterinarians and other referral sources and to engage in other marketing activities, including direct to consumer advertising, which are likely to increase our acquisition costs.

We expect to continue to make significant expenditures to maintain and expand our business including expenditures relating to the acquisition of new members, retention of our existing members and development and implementation of our technology platforms. These increased expenditures will make it more difficult for us to achieve and maintain future profitability. Our ability to achieve and maintain profitability depends on a number of factors, including our ability to attract and service members on a profitable basis. If we are unable to achieve or maintain profitability, we may not be able to execute our business plan, our prospects may be harmed and our stock price could be materially and adversely affected.

We base our decisions regarding our member acquisition expenditures primarily on the projected lifetime value of the pets that we expect to acquire and the projected internal rate of return on marketing spend. Our estimates and assumptions may not accurately reflect our future results, we may overspend on member acquisition, and we may not be able to recover our member acquisition costs or generate profits from these investments.

We invest significantly in member acquisition. We expect to continue to spend significant amounts to acquire additional members. We utilize Territory Partners, who are paid fees based on activity in their regions, to communicate the benefits of our subscription to veterinarians through in-person visits. Veterinarians then educate pet owners, who visit our website or call our contact center to learn more about, and potentially enroll in, our subscription. We also invest in other third-party referrals and direct to consumer member acquisition channels, though we have limited experience with some of them.

We base our decisions regarding our member acquisition expenditures primarily on the lifetime value of the pets that we project to acquire. This analysis depends substantially on estimates and assumptions based on our historical experience with pets enrolled in earlier periods, including our key operating metrics described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Operating Metrics.”

If our estimates and assumptions regarding the lifetime value of the pets that we project to acquire and our related decisions regarding investments in member acquisition prove incorrect, or if the expected lifetime value of the pets that we project to acquire differs significantly from that of pets acquired in prior periods, we may be unable to recover our member acquisition costs or generate profits from our investment in acquiring new members. Moreover, if our member acquisition costs increase or we invest in member acquisition channels that do not ultimately result in any or an adequate number of new member enrollments, the return on our investment may be lower than we anticipate irrespective of the lifetime value of the pets that we project to acquire as a result of the new members. If we cannot generate profits from this investment, we may need to alter our growth strategy, and our growth rate and operating results may be adversely affected.

If we are unable to maintain high member retention rates, our growth prospects and revenue will be adversely affected.

We have historically experienced high average monthly retention rates. For example, our average monthly retention rate between 2010 and 2017 was 98.5%. If our efforts to satisfy our existing members are not successful or if new marketing initiatives result in enrolling more pets that inherently have a lower retention rate, we may not be able to maintain our retention rates. Members we obtain through aggressive promotions or other channels that involve relatively less meaningful contact between us and the member may be more likely to terminate their subscription. In the past, we have experienced reduced retention rates during periods of rapid member growth, as our retention rate generally has been lower during the first year of member enrollment. Members may choose to terminate their subscription for a variety of reasons, including perceived or actual lack of value, delays or other unsatisfactory experiences in how we review and process veterinary invoice payments, unsatisfactory member service, an economic downturn, increased subscription fees, loss of a pet, a more attractive offer from a competitor, changes in our subscription or other reasons, including reasons that are outside of our control. Our cost of acquiring a new member is substantially greater than the cost involved in maintaining our relationship with an existing member. If we are not able to successfully retain existing members and limit terminations, our revenue and operating margins will be adversely impacted and our business, operating results and financial condition would be harmed.

The prices of our subscriptions are based on assumptions and estimates and may be subject to regulatory approvals. If our actual experience differs from the assumptions and estimates used in pricing our subscriptions or if we are unable to obtain any necessary regulatory pricing approvals we need, at all or in a timely manner, our revenue and financial condition could be adversely affected.

The pricing of our subscriptions reflect amounts we expect to pay for a pet's medical care derived from assumptions that we make regarding a number of factors, including a pet’s species, breed, age, gender and location. Factors related to pet location include the current and assumed changes in the cost and availability of veterinary technology and treatments and local veterinary practice preferences. The prices of our subscriptions also include assumptions and estimates regarding our own operating costs and expenses. We monitor and manage our pricing and overall sales mix to achieve target returns. Profitability from new members emerges over a period of years depending on the nature and length of time a pet is enrolled, and is subject to variability as actual results may differ from pricing assumptions. If the subscription fees we collect are insufficient to cover actual costs, including veterinary invoice expense, operating costs and expenses within anticipated pricing allowances, or if our member retention rates are not high enough to ensure recovery of member acquisition costs, then our gross profit could be adversely affected, and our revenue may be insufficient to achieve profitability. Conversely, if our pricing assumptions differed from actual results such that we overpriced risks, our competitiveness and growth prospects could be adversely affected. Further, even if our pricing assumptions are accurate, we may not be able to obtain the necessary regulatory approvals for any pricing changes that we may determine are appropriate based on our pricing assumptions, which could prevent us from obtaining sufficient revenue from subscriptions to cover our costs, including veterinary invoice expense, processing costs, pet acquisition costs and other expenses in any such jurisdiction unless and until such regulatory approvals are obtained in appropriate amounts.

The anticipated benefits of our analytics platform may not be fully realized.

Our analytics platform draws upon our proprietary pet data to price our subscriptions. The assumptions we make about breeds and other factors in pricing may prove to be inaccurate and, accordingly, these pricing analytics may not accurately reflect the expense that we will ultimately incur. Furthermore, if any of our competitors develop similar or better data systems, adopt similar or better underwriting criteria and pricing models or receive our data, our competitive advantage could decline or be lost.

Our actual veterinary invoice expense may exceed our current reserve established for veterinary invoices and may adversely affect our operating results and financial condition.

Our recorded reserve for veterinary invoices is based on our best estimates of the amount of veterinary invoices we expect to pay, inclusive of an estimate for veterinary invoices we have not yet received, after considering known facts and interpretations of circumstances and the estimated cost to process and pay those veterinary invoices. We consider internal factors, including data from our proprietary data analytics platform, experience with similar cases, actual veterinary invoices paid, historical trends involving veterinary invoice payment patterns, patterns of receipt of veterinary invoices, seasonality, pending levels of unpaid veterinary invoices, veterinary invoice processing programs and contractual terms. We may also consider external factors, including changes in the law, court decisions, changes to regulatory requirements and economic conditions. Because reserves are estimates of veterinary invoices that have been incurred but are not yet submitted to us, the establishment of appropriate reserves is an inherently uncertain and complex process that involves significant subjective judgment. Further, we do not transfer or cede our risk as an insurer and, therefore, we maintain more risk than we would if we purchased reinsurance. The ultimate cost of paying veterinary invoices and the related administration may vary materially from recorded reserves, and such variance may result in adjustments to the reserve for veterinary invoices, which could have a material effect on our operating results.

We rely significantly on Territory Partners, veterinarians and other third parties to recommend us.

We rely significantly on Territory Partners and other third parties to cultivate direct veterinary relationships and build awareness of the benefits that we offer veterinarians and their clients. In turn, we rely on veterinarians to introduce and recommend Trupanion to their clients. We also rely significantly on other third parties, such as existing members, online and other businesses, animal shelters, breeders and veterinary affiliates, including veterinarian purchasing groups and associations, to help generate leads for our subscription. Veterinary referred leads represent our largest member acquisition channel. In the three months ended March 31, 2017, approximately 72% of our enrollments came from referrals from veterinarians and existing members, as well as people adding pets to their existing subscription.

Many factors influence the success of our relationships with these referral sources, including:


•	the continued positive market presence, reputation and growth of our company and of the referral sources;


•	the effectiveness of referral sources;


•	the decision of any such referral source to support one or more of our competitors;


•	the interest of the referral sources’ customers or clients in our subscription;


•	the relationship and level of trust between Territory Partners and veterinarians, and between us and the referral source;


•	the percentage of the referral sources’ customers or clients that submit applications or use trial certificates to enroll through our website or contact center;


•	our ability to implement or maintain any marketing programs, including trial certificates, in any jurisdiction; and


•	our ability to work with the referral source to implement any changes in our marketing initiatives, including website changes, infrastructure and technology and other programs and initiatives necessary to generate positive consumer experiences.

In order for us to implement our business strategy and grow our revenue, we must effectively maintain and increase the number and quality of our relationships with Territory Partners, veterinarians and other referral sources, and continue to scale and improve our processes, programs and procedures that support them. Those processes, programs and procedures could become increasingly complex and difficult to manage. We expend significant time and resources attracting qualified Territory Partners and providing them with complete and current information about our business. Their relationship with us may be terminated at any time, and, if terminated, we may not recoup the costs associated with educating them about our subscription or be able to maintain any relationships they may have developed with veterinarians within their territories. Sometimes a single relationship may be used to cover multiple territories so that a terminated relationship could significantly impact our company. Further, if we experience an increase in the rate at which Territory Partner relationships are terminated, we may not develop or maintain relationships with veterinarians as quickly as we have in the past. If the financial cost to maintain our relationships with Territory Partners outweighs the benefits provided by Territory Partners, or if they feel unsupported or undervalued by us and terminate their relationship with us, our growth and financial performance could be adversely affected.

The success of our relationships with veterinary practices depends on the overall value we can provide to veterinarians. If the scope of our subscription is perceived to be inadequate or if our process for paying veterinary invoices is unsatisfactory to the veterinarians' clients because, for example, a service is not included in our subscription, member requests for reimbursement are denied or we fail to timely settle and pay veterinary invoices, veterinarians may be unwilling to recommend us to their clients and they may encourage their existing clients who have subscribed to stop or to purchase a competing product. If veterinarians determine our subscription is unreliable, cumbersome or otherwise does not provide sufficient value, they may terminate their relationship with us or begin recommending a competing product, which could negatively impact our ability to increase our member base and grow our business.

If we fail to establish or are unable to maintain successful relationships with Territory Partners, veterinarians and other referral sources, or experience an increase in the rate at which any of these relationships are terminated, it could negatively impact our ability to increase and retain our member base and our financial results. If we are unable to maintain our existing member acquisition channels and/or continue to add new member acquisition channels, if the cost of our existing sources increases or does not scale as we anticipate, or if we are unable to continue to use any existing channels or programs in any jurisdiction, including our trial certificate program, our member levels and sales and marketing expenses may be adversely affected.

Territory Partners are independent contractors and, as such, may pose additional risks to our business.

Territory Partners are independent contractors and, accordingly, we do not directly provide the same direction, motivation and oversight over Territory Partners as we otherwise could if Territory Partners were our own employees. Further, Territory Partners may themselves employ or engage others; we refer to these partners and their associates, collectively, as our Territory Partners. We do not control a Territory Partner’s employment or engagement of others, and it is possible that the actions of their employees and/or contractors could create threatened or actual legal proceedings against us.

Territory Partners may decide not to participate in our marketing initiatives and/or training opportunities, accept our introduction of new solutions or comply with our policies and procedures applicable to them, any of which may adversely affect our ability to develop relationships with veterinarians and grow our membership. Our sole recourse against Territory Partners who fail to perform is to terminate their contract, which could also trigger contractually obligated termination payments or result in disputes, including threatened or actual legal or regulatory proceedings.

We believe that Territory Partners are not and should not be classified as employees under existing interpretations of the applicable laws of the jurisdictions in which we operate. We do not pay or withhold any employment tax with respect to or on behalf of Territory Partners or extend any benefits to them that we generally extend to our employees, and we otherwise treat Territory Partners as independent contractors. Applicable authorities or the Territory Partners have in the past questioned and may in the future challenge this classification. Further, the applicable laws or regulations, including tax laws or interpretations, may change. If it were determined that we had misclassified any of our Territory Partners, we may be subjected to penalties and/or be required to pay withholding taxes, extend employee benefits, provide compensation for unpaid overtime, or otherwise incur substantially greater expenses with respect to Territory Partners.

Any of the foregoing circumstances could have a material adverse impact on our operating results and financial condition.

Our member base has grown rapidly in recent periods, and we may not be able to maintain the same rate of membership growth.

Our ability to grow our business and to generate revenue depends significantly on attracting new members. In order to continue to increase our membership, we must continue to offer a superior value to our members. Our ability to continue to grow our membership will also depend in part on the effectiveness of our sales and marketing programs. Our member base may not continue to grow or may decline as a result of increased competition or the maturation of our business.

We may not maintain our current rate of revenue growth.

Our revenue has increased quickly and substantially in recent periods. We believe that our continued revenue growth will depend on, among other factors, our ability to:


•	improve our market penetration through efficient and effective sales and marketing programs to attract new members;


•	maintain high retention rates;


•	increase the lifetime value per pet to, in turn, enable us to spend more on sales and marketing programs;


•	maintain positive relationships with veterinarians and other referral sources, and convince them to recommend our subscription;


•	maintain positive relationships with and increase the number and efficiency of Territory Partners;


•	continue to offer a superior value with competitive features and rates;


•	accurately price our subscriptions in relation to actual member costs and operating expenses and achieve required regulatory approval for pricing changes;


•	provide our members with superior member service, including timely and efficient payment of veterinary invoices, and by recruiting, integrating and retaining skilled and experienced personnel who can appropriately and efficiently review veterinary invoices and process payments;


•	generate new and maintain existing relationships and programs in our other business segment;


•	recruit, integrate and retain skilled, qualified and experienced sales department professionals who can demonstrate our value proposition to new and existing members;


•	react to changes in technology and challenges in the industry, including from existing and new competitors;


•	increase awareness of and positive associations with our brand; and


•	successfully respond to any regulatory matters and defend any litigation.

You should not rely on our historical rate of revenue growth as an indication of our future performance.

Our use of capital may be constrained by risk-based capital regulations or contractual obligations.

Our subsidiary, American Pet Insurance Company, is subject to risk-based capital regulations that require us to maintain certain levels of surplus to support our overall business operations in consideration of our size and risk profile. We have in the past and may in the future fail to maintain the amount of risk-based capital required to avoid additional regulatory oversight. To comply with these regulations and our related contractual obligations, we may be required to maintain capital that we would otherwise invest in our growth and operations, which may require us to modify our operating plan or marketing initiatives, delay the implementation of new solutions or development of new technologies, decrease the rate at which we hire additional personnel and enter into relationships with Territory Partners, incur indebtedness or pursue equity or debt financings or otherwise modify our business operations, any of which could have a material adverse effect on our operating results and financial condition.

We are also subject to a contractual obligation related to our reinsurance agreement with Omega General Insurance Company (Omega). Under this agreement, we are required to fund a Canadian Trust account in accordance with Canadian regulations.

Unexpected increases in the number or amounts of veterinary invoices received, or that we expect to receive, may negatively impact our operating results.

Unexpected changes in the number or amounts of veterinary invoices received, or that we expect to receive, may negatively impact our operating results. Rising costs of veterinary care and the increasing availability and usage of more expensive, technologically advanced medical treatments may increase the amounts of veterinary invoices we receive. Increases in the number of veterinary invoices we receive could arise from unexpected events that are inherently difficult to predict, such as a pandemic that spreads through the pet population, tainted pet food or supplies or an unusually high number of serious injuries or illnesses. We may experience volatility in the number of veterinary invoices we receive from time to time, and short-term trends may not continue over the longer term. The number of veterinary invoices may be affected by the level of care and attentiveness an owner provides to the pet, the pet’s breed and age and other factors outside of our control, as well as fluctuations in member retention rates and by new member initiatives that encourage an increase in veterinary invoices and other new member acquisition activities. A significant increase in the number or amounts of veterinary invoices could increase our cost of revenue and have a material adverse effect on our financial condition.

Our success depends on our ability to review, process, and pay veterinary invoices timely and accurately.

We must accurately evaluate and pay veterinary invoices timely in a manner that gives our members high satisfaction. Many factors can affect our ability to do this, including the training, experience and skill of our personnel, our ability to reduce the number of payment requests made for services not included in our subscription, the department’s culture and the effectiveness of its management, our ability to develop or select and implement appropriate procedures, supporting technologies and systems, and changes in our policy. Our failure to fairly pay veterinary invoices, accurately and in a timely manner, or to deploy resources appropriately, could result in unanticipated costs to us, lead to material litigation, undermine member goodwill and our reputation, and impair our brand image and, as a result, materially and adversely affect our competitiveness, financial results, prospects and liquidity.

We may not identify fraudulent or improperly inflated veterinary invoices.

It is possible that a member, or a third-party actually or purportedly on behalf of the member, could submit a veterinary invoice which we would then pay that appears authentic but in fact does not reflect services provided or products purchased for which the member paid. It is also possible that veterinarians will charge insured customers higher amounts than they would charge their non-insured clients for the same service or product. Such activity could lead to unanticipated costs to us and/or to time and expense to recover such costs. They could also lead to strained relationships with veterinarians and/or members, and could adversely affect our competitiveness, financial results and liquidity.

Changes in the Canadian currency exchange rate may adversely affect our revenue and operating results.

We offer our subscription in Canada, which exposes us to the risk of changes in the Canadian currency exchange rates. Fluctuations in the relative strength of the Canadian economy and the Canadian dollar has in the past and could in the future adversely affect our revenue and operating results.

We are and will continue to be faced with many competitive challenges, any of which could adversely affect our prospects, operating results and financial condition.

We compete with pet owners that self-finance unexpected veterinary invoices with savings or credit, as well as traditional "pet insurance" providers and relatively new entrants into our market. The vast majority of pet owners in the United States and Canada do not currently have medical insurance for their pets. We are focused primarily on expanding our share of the overall market, and we view our primary competitive challenge as educating pet owners on why our subscription is a better alternative to self-financing.

Additionally, there are traditional insurance companies that provide pet insurance products, either as a stand-alone product or along with a broad range of other insurance products. In addition, new entrants backed by large insurance companies have attempted to enter the pet insurance market in the past and may do so again in the future. Further, traditional "pet insurance" providers may consolidate or take other actions to mimic the efficiencies from our vertically-integrated structure or create other operational efficiencies, which could lead to increased competition.

Some of our current and potential competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, technical, marketing and other resources than we do. Some of our competitors may be able to undertake more extensive marketing initiatives for their brands and services, devote more resources to website and systems development and make more attractive offers to potential employees, referral sources and third-party service providers.

To compete effectively, we will need to continue to invest significant resources in sales and marketing, in improving our member service levels, in the online experience and functionalities of our website and in other technologies and infrastructure. Failure to compete effectively against our current or future competitors could result in loss of current or potential members, subscription terminations or a reduction in member retention rates, which could adversely affect our pricing, lower our revenue and prevent us from achieving or maintaining profitability. We may not be able to compete effectively for members in the future against existing or new competitors, and the failure to do so could result in loss of existing or potential members, increased sales and marketing expenses or diminished brand strength, any of which could harm our business.

If we are not successful in cost-effectively converting visitors to our website and contact center into members, our business and operating results would be harmed.

Our growth depends in large part upon growth in our member base. We seek to convert consumers who visit our website and call our contact center into members. The rate at which consumers visiting our website and contact center considering enrollment in our subscription are converted into members is a significant factor in the growth of our member base. A number of factors have influenced, and could in the future influence, the conversion rates for any given period, some of which are outside of our control. These factors include:


•	the competitiveness of our subscription, including its perceived value, simplicity, and fairness;


•	changes in consumer shopping behaviors due to circumstances outside of our control, such as economic conditions and consumers’ ability or willingness to pay for our product;


•	the quality of and changes to the consumer experience when speaking with us on the phone or using our website;


•	regulatory requirements, including those that make the experience on our website cumbersome or difficult to navigate or that hinder our ability to speak with potential members quickly and in a way that is conducive to converting leads, enrolling new pets, and/or resolving member concerns;


•	system failures or interruptions in the operation of our abilities to write policies or operate our website or contact center; and


•	changes in the mix of consumers who are referred to us through various member acquisition channels, such as veterinary referrals, existing members adding a pet and referring their friends and family members and other third-party referrals and direct-to-consumer acquisition channels.

Our ability to convert consumers into members can be impacted by a change in the mix of referrals received through our member acquisition channels. In addition, changes to our website or contact center, or other programs or initiatives we undertake, may adversely impact our ability to convert consumers into members at our current rate, or at all. These changes may have the unintended consequence of adversely impacting our conversion rates. A decline in the percentage of members who enroll in our subscription on our website or by calling our contact center also could result in increased member acquisition costs. To the extent the rate at which we convert consumers into members suffers, the growth rate of our member base may decline, which would harm our business, operating results and financial condition.

We have made and plan to continue to make substantial investments in features and functionality for our website and training and staffing for our contact center that are designed to generate traffic, increase member engagement and improve new and existing member service. These activities do not directly generate revenue, however, and we may never