Three months ended September 30, 2017 compared to three months ended September 30, 2016. Total other expense (income), net decreased by $0.1 million for the three months ended September 30, 2017 primarily driven by an increase in interest income.
Nine months ended September 30, 2017 compared to nine months ended September 30, 2016. Total other expense (income), net decreased by $1.0 million for the nine months ended September 30, 2017 primarily due to a $1.0 million gain on sale of an equity method investment.
Liquidity and Capital Resources
Since inception, we have financedThe following table summarizes our cash flows for the periods indicated (in thousands):
| | | | | | | | | | | |
| Nine months ended September 30, |
| 2020 | | 2019 |
| Net cash provided by operating activities | $ | 17,580 | | | $ | 11,625 | |
| Net cash used in investing activities | (18,579) | | | (22,791) | |
| Net cash provided by financing activities | 7,275 | | | 9,374 | |
| Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash, net | (214) | | | 267 | |
| Net change in cash, cash equivalents and restricted cash | $ | 6,062 | | | $ | (1,525) | |
Our primary sources of liquidity are cash provided by operations and met capitalavailable borrowings on our line of credit. We currently have a revolving line of credit of up to $50.0 million. Our primary requirements primarily through the sale of equity securities, from borrowings and from cash flows provided by operating and other activities. Our principal uses of cashfor 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.
Sources of Funds
As of September 30, 2017,2020, we had $59.3$118.3 million in cash, cash equivalents and short-term investments and $21.0$19.9 million available under our line of credit, facility which excludes $1.5excluded $0.2 million reserved under the credit agreement for an outstanding letter of credit and other ancillary services. We believe that our existing cash, cash equivalents, short-term investments and lineMost of credit will be sufficient to fund our operations and statutory capital requirements for at least the next 12 months. From time to time, we may explore additional financing, which could include equity, equity-linked and debt financing. However, there can be no assurance that any additional financing will be available to us on acceptable terms, or at all.
Cash and investments held byassets in our insurance subsidiaries,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 as applicable within theprescribed by jurisdictions in which they are authorized to operate. As of September 30, 2020, total assets and liabilities held outside of our insurance entities were $95.3 million and $51.2 million, respectively, including $5.5 million of cash and cash equivalents that were segregated from other operating funds and held in trust for the payment of veterinary invoices on behalf of our insurance subsidiaries. For morefurther 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 and consider strategic opportunities, however, we may explore additional financing to fund our operations or to meet capital requirements, including our financing with Aflac and related expenses associated with the Alliance. Financing could include equity, equity-linked, or debt financing. Additional financing may not be available to us on acceptable terms, or at all.
In November 2019, our board of directors approved a share repurchase program, pursuant to which we may repurchase up to $15.0 million of our outstanding shares over the 12 months following the approval. Each quarter throughout this period, we intend to establish repurchase parameters reflecting our business’s capital allocation priorities, our stock price relative to our estimated intrinsic value, and general market conditions. We cannot predict the timing or extent of any repurchases of shares of common stock, as such repurchases will depend on a number of factors, some of which are beyond our control. We did not repurchase any shares under this program during the quarter ended September 30, 2020.
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 $17.6 million for the nine months ended September 30, 2020 compared to $11.6 million for the nine months ended September 30, 2019. The change see "Liquiditywas primarily driven by increased pet count and Capital Resources—Regulation."scale in our operating departments, as well as the timing differences between collections from members and payments of veterinary invoices and payments to vendors. Changes in accounts receivable were primarily related to annual policies with monthly payment terms within our other business segment.
Investing Cash Flows
Cash used in investing activities is primarily related to the net purchase of investments to increase our statutory capital. Net cash used in investing activities decreased by $4.2 million for the nine months ended September 30, 2020 compared to the same period in prior year, primarily due to a $3.1 million lower net purchase of investments.
Financing Cash Flows
Cash provided by financing activities was $7.3 million and $9.4 million for the nine months ended September 30, 2020 and 2019, respectively. The decrease of $2.1 million was primarily due to $3.0 million less drawn from our line of credit as well as a $2.5 million repayment in the current period, partially offset by $3.0 million higher net proceeds from exercise of stock options.
Long-Term Debt
Pacific Western Bank Loan and Security Agreement
In December 2016, we entered intoWe have a syndicated loan agreement with Pacific Western Bank (PWB) and Western Alliance Bank (WAB) that increased our previous facility from $20.0, providing us a revolving line of credit of up to $50.0 million, to $30.0 million. The agreement was amended during the current year to extend thewith a maturity date to December 2019.in June 2022. We refer to the restated and amended loan and security agreementthis line of credit as our PWB credit facility. The PWB credit facility provides for a revolving line of credit, under which we may take advances up to $30.0 million. 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$50.0 million or the total amount of cash and securities held by our insurance subsidiaries (APIC and WICL),entities, less $1.5 million for obligations we haveamounts outstanding from PWB and/or WAB forrelating to other ancillary services and our letterletters of credit.
credit, totaling $0.2 million as of September 30, 2020. Interest on the PWB credit facility accrues at a variable annual rate equal to the greater of 4.5%, or 1.25%0.75% plus the prime rate. The PWB credit facility matures in December 2019.rate (4.50% at September 30, 2020).
The PWB credit facility requires us to maintain certain financial and non-financial covenants, including having APIC maintain statutory capital and surplus at all times of not less than the greater of the amount required by APIC or 110% of the highest amount of statutory capital and surplus required in any state in which APIC is licensed; maintaining a minimum cash balance of $0.6$1.4 million in our account at WAB and/or WAB affiliates and other cash or investments of $1.4$2.1 million in our accounts at PWB; maintaining all of our depository and operating accounts at PWB and/or WAB; maintaining certain investment accounts at PWB and/or PWB affiliates; achieving certain quarterly revenue levels and claims ratio thresholds; maintaining greater than negative $1.0 million net total of operating cash flow and capital expenditures quarterly, and remaining within certain monthly maximum EBITDA loss levels. EBITDA is defined as earnings, plus an amount equal to the sum of (i) tax, plus (ii) depreciation and amortization, plus (iii) interest and non-cash expenses, plus (iv) any non-cash stock-based compensation expense, plus (v) (gain)/loss from equity method investments.
The PWB credit facility also requires us to maintain certain non-financial covenants, including those that restrict our ability to dispose of our assets, change the name, location, office or executive management of our business, merge with or acquire other entities, incur other indebtedness, incur encumbrances, pay dividends or make distributions to holders of our capital stock, make investments, engage in transactions with our affiliates, permit withdrawals from APIC (with certain exceptions) and conduct operations in certain of our Canadian subsidiaries.
PWB. As of September 30, 2017,2020, 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 September 30, 2017,2020, we had $7.5$30.0 million in aggregate borrowings outstanding under the PWB credit facility.
Regulation
As of September 30, 2017,2020, our insurance entities, APIC and WICL Segregated Account AX, held $34.0$83.0 million in short-term investments and $22.4$116.4 million in other current assets, including $4.6$23.1 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. As of September 30, 2017, total assets and liabilities held outside of our insurance entities totaled $42.5 million and $18.8 million, respectively, including $17.9 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.
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, 2016,2019, APIC was required to maintain at least $25.8$55.3 million of risk-based capital to avoid this additional regulatory oversight. As of that date, APIC maintained $30.5$73.8 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. In general, 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, 2016, less than $0.1 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 January 2017,February 2020, our parent entity received a dividend of $2.7$4.7 million from WICL Segregated Account AX as allowed under our agreements with WICL. As required by the Office of the Superintendent of Financial Institutions regulations related to our reinsurance agreement with Omega General Insurance Company, we are required to maintain a Canadian Trust account with the greater of CAD $2.0 million or 115%120% of unearned Canadian premium plus 15%20% of outstanding Canadian claims, including all incurred but not reported claims. As of December 31, 2019, the account held CAD $4.3 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.
Investments
As of September 30, 2017, we had $37.1 million in short-term and long-term investments in our insurance entities. These investments are held to satisfy statutory requirements and support operating needs. The majority of our investments are highly rated U.S. treasury securities, certificates of deposit, and U.S. government funds. In addition, we have one investment in a municipal bond that is insured by a third-party insurance company with a rating of "A2" with Moody’s as of September 30, 2017.
Historical Cash Flow Trends
The following table shows a summary of our cash flows for the periods indicated (in thousands):
|
| | | | | | | |
| | Nine Months Ended September 30, |
| | 2017 | | 2016 |
| Net cash provided by operating activities | $ | 6,689 |
| | $ | 1,568 |
|
| Net cash used in investing activities | (8,433 | ) | | (5,091 | ) |
| Net cash provided by financing activities | 2,920 |
| | 5,952 |
|
| Effect of foreign exchange rates on cash | 436 |
| | 241 |
|
| Net change in cash, cash equivalents and restricted cash | $ | 1,612 |
| | $ | 2,670 |
|
Operating Cash Flows
We derive operating cash flows from cash collected from the sale of subscriptions to our medical plan, which is used to pay member veterinary invoices, other cost of revenue, and operating expenses. Additionally, cash is used to support the growth of our business by reinvesting to acquire new pets and projects to improve member experience.
Net cash provided by operating activities for the nine months ended September 30, 2017 was $6.7 million compared to $1.6 million for the nine months ended September 30, 2016. The increase of $5.1 million was driven by higher revenue and decreased operating expenses as a percentage of revenue as we increased scale in our technology and general and administrative departments.
Investing Cash Flows
Net cash used in investing activities for the nine months ended September 30, 2017 was $8.4 million compared to $5.1 million for the nine months ended September 30, 2016. The increase of $3.3 million was primarily related to a $2.6 million note receivable and an additional $1.4 million of net purchases of investments to increase our statutory capital as we increase total pets enrolled. These cash outflows were partially offset by proceeds of $1.4 million from the sale of an equity method investment.
Financing Cash Flows
Net cash provided by financing activities for the nine months ended September 30, 2017 was $2.9 million compared to $6.0 million for the nine months ended September 30, 2016. The decrease of $3.1 million was primarily related to $1.5 million less in draws on our line of credit and $0.7 million less proceeds from exercises of stock options.
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.vendor service agreements. Management believes there have been no material changes to our contractual obligation disclosure during the nine months endedas of September 30, 2017,2020, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.2019.
Critical Accounting Policies and Significant Estimates
Our discussion and analysis of our financial condition and results of operations areis 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 related disclosure of contingent assets and liabilities revenue, and expenses atas of the date of the consolidated financial statements.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 assumptions in accordance with GAAPfactors 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 estimatesthose described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
2019.
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 nine months ended September 30, 2017,2020, compared to those discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
2019.
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, we may beare subject to various legal proceedingslitigation matters and claims inarising from the ordinary course of business, activities, 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 general contractregulatory or other claims.governmental investigations or disputes. We may, from timerecord an estimated liability relating to time, alsosuch 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 varioussignificant uncertainties, and could be material to our operating results for a particular period. We review our estimates at least quarterly and makes adjustments to reflect the outcome of negotiations, estimated settlements, legal rulings, advice of legal counsel and other legal or government claims, disputes or investigations.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
Our results of operations may be adversely impacted by the COVID-19 pandemic.
The global spread of the COVID-19 pandemic and related containment efforts have created significant economic disruption. To date, the pandemic has not had a material adverse impact on our business, although we expect that our near-term growth rate may decline slightly. For example, COVID-19 has resulted in a significant unemployment. The related economic impact on consumers may result in decreased new enrollments and increased cancellations. Our Territory Partners are less able to drive new enrollments by conducting face-to-face visits with veterinarians and their staff. In addition, veterinarians have reported that pets may contract COVID-19, and the extent to which COVID-19 may be communicable among humans, dogs and cats and its health impact on pets is somewhat uncertain. An increase in COVID-19 among pets may cause our veterinary invoice expense to increase. Meanwhile, while we are not currently experiencing any meaningful decreases in veterinary invoice expenses, many insurance companies within the property and casualty insurance space are providing refunds to policyholders in light of reduced claims trends they are experiencing, and it is possible that state insurance regulators may require us to change our behavior. In addition, the duration of the pandemic, whether it may recur, and its other long-term impacts are highly uncertain and cannot be predicted. These risks and uncertainties make it challenging to manage our growth, maintain business relationships, price our subscription and otherwise plan for our business.
In accordance with local and state directives, we have shifted our operations from our corporate office facility located in Seattle, Washington, and substantially all of our personnel are working from home. We have not conducted business in this manner previously, do not know how long we may need to continue in this manner, and may experience reduced productivity of our employees, greater exposure to cybersecurity threats, or other operational risks. Similarly, many of our Territory Partners, our vendors, the businesses for which we write policies in our other business segment, and our strategic partners are working from home, and many veterinary hospitals are working at reduced staffing levels. The extent to which these parties suffer inefficiencies or other risks from their work-from-home arrangements, and the extent to which those risks may impact us, is impossible to predict.
We have incurred significant cumulative net losses since our inception and may not be able to achieve or maintain profitability in the future.
We have incurred significant cumulative net losses since our inception. We had aincurred net losslosses of $0.7$1.8 million forand $0.9 million in the nine monthsyears ended September 30, 2017. Additionally,December 31, 2019 and 2018, respectively, and as of September 30, 2017, ourDecember 31, 2019, we had an accumulated deficit was $81.9of $85.5 million. We have funded our operations through equity financings, borrowings under a revolving line of credit and term loans and, more recently,since 2016, positive cash flows from operations. We may not be ableOur ability to achieve or maintain profitability will depend in the near future or at all.significant part on our obtaining new members, retaining our existing members and ensuring that our expenses, including our sales and marketing expenses, does not exceed our revenue. We expect to make significant expenditures and investments in member acquisition. 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, we budget for our expense levels areexpenses 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.estimates. Accordingly, any significant shortfall of revenue in relation to our estimates could have an immediate negative effect on our financial results.
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 cost-efficient and effective sales and marketing programs to attract new members;
•convert leads into enrollments;
•maintain high retention rates;
•increase the lifetime value per pet;
•maintain positive relationships with veterinarians and other lead sources;
•maintain positive relationships with and increase the number and efficiency of Territory Partners;
•continue to offer a superior value with competitive features and rates;
•price our subscriptions in relation to actual operating expenses and achieve required regulatory approval for pricing changes;
•recruit, integrate and retain skilled, qualified and experienced sales department professionals who can demonstrate our value proposition to new and existing members;
•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 efficiently review veterinary invoices and process payments;
•generate new and maintain existing relationships and programs in our other business segment;
•react to existing and new competitors;
•increase awareness of and positive associations with our brand;
•react to unexpected developments and general macroeconomic conditions, including pandemics and related economic impacts; and
•successfully respond to and comply with regulations affecting our business and defend or prosecute any litigation.
You should not rely on our historical rate of revenue growth as an indication of our future performance.
We base our decisions regarding member acquisition expenditures primarily on 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 have made and plan to continue to make significant investments to grow our member base. We spent $33.3 million on sales and marketing to acquire new members for the year ended December 31, 2019. Our average pet acquisition cost and the number of new pets we enroll depends on a number of factors and assumptions, 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 increased over time and has significantly varied in the past significantly varied and inpast. In the future, our average pet acquisition cost may continue to rise and 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
In addition, 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 valueour internal rate of the pets that we expect to acquire. Our estimates and assumptions may not accurately reflect our future results, we may overspendreturn generated 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 spent $13.3 million on sales and marketing to acquire new members for the nine months ended September 30, 2017. 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 medical plan 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 medical plan. 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.an average pet. This analysis depends substantially on estimates and assumptions based on our historical experience with pets enrolled in earlier periods, including our key financial and operating metrics described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Financial and Operating Metrics.”
metrics. If our estimates and assumptions regarding our internal rate of return and 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 expectedour calculation of internal rate of return and 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.
We depend in part on Internet search engines to attract potential new members to visit our website. If Internet search engines’ methodologies are modified or our search result page rankings decline for other reasons, our new member growth could decline, and our business and operating results could be harmed.
We derive a significant amount of traffic to our website from consumers who search for pet medical insurance through Internet search engines, such as Google, Bing and Yahoo!. A critical factor in attracting consumers searching for pet medical insurance on the Internet to our website is whether we are prominently displayed in response to an Internet search relating to pet insurance. Algorithmic search result listings are determined and displayed in accordance with a set of formulas or algorithms developed by the particular Internet search engine, which may change from time to time. If we are listed less prominently in, or removed altogether from, search result listings for any reason, the traffic to our websites would decline and we may not be able to replace this traffic, which in turn would harm our business, operating results and financial condition. If we decide to attempt to replace this traffic, we may be required to increase our sales and marketing expenditures, including by utilizing paid search advertising. Certain of our competitors have spent additional funds to promote their products in search results over us. If we decide to respond by purchasing search advertising, our pet acquisition costs would increase which may harm our business, operating results and financial condition.
If we are unable to grow our member base and maintain high member retention rates, our growth prospects and revenue will be adversely affected.
Our ability to grow our business depends on retaining and expanding our member base. For the year ended December 31, 2019, we generated 83.7% of our revenue from subscriptions. In order to continue to increase our membership, we must continue to convince prospective members of the benefits of pet insurance and existing members of the continuing value of our product.
We utilize Territory Partners, who are paid fees based on enrollments in their regions, to communicate the benefits of medical insurance to veterinarians through in-person visits. Veterinarians then educate pet owners, who visit our website or call our contact center to learn more about these benefits, and potentially become members. We also invest in other third-party and direct to consumer member acquisition channels, though we have limited experience with some of them. We plan to expand the number of our Territory Partners and other lead-generation sources and to engage in other marketing activities, including direct to consumer advertising, which are likely to increase our acquisition costs. In addition, these plans may face unexpected delays, costs or other challenges, such as decreased ability of Territory Partners to conduct in-person veterinarian or less effective development of other third-party relationships.
We seek to convert consumers who visit our website and call our contact center into members. The rate at which we convert these visitors 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;
•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 conversion;
•system failures or interruptions in our website or contact center; and
•changes in the mix of consumers who learn about us through various member acquisition channels.
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 member service. These activities do not directly generate revenue, however, and we may never realize any benefit from these investments. If the expenses that we incur in connection with these activities do not result in sufficient growth in members to offset the cost, our business, operating results and financial condition will be adversely affected.
We have historically experienced high average monthly retention rates. For example, our average monthly retention rate frombetween 2010 through 2016and 2019 was 98.5%. We expect to continue to make significant expenditures relating to the retention of existing members, including an increase in the number of inside account managers and development and implementation of new technology platforms designed to encourage retention of these members.
If our efforts to satisfywe do not retain our existing members are not successful or if newour marketing initiatives do not result in enrolling more pets or result in enrolling pets that inherently have a lower retention rate, we may not be able to maintain our retention and new member acquisition rates. Members we obtain through aggressive promotions or other channels that involve relatively less meaningful contact between us and the member may beare more likely to terminate their medical plan 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 medical plan subscription for a variety of reasons, including increased subscription fees, perceived or actual lack of value, delays or other unsatisfactory experiences in claims administration,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 medical plansubscription or other reasons, including reasons that are outside of our control. When a member terminates his or her medical plan subscription, we no longer receive the related revenue and may not be able to recover the member acquisition cost or other expenses, including claims expenses, related to that member. 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 medical plan subscription 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 medical plan 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 medical plan 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 medical plan subscriptions reflect expected claim payment patterns 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 medical plan 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 in our medical plan, and is subject to variability as actual results may differ from pricing assumptions. If the subscription fees we collect are insufficient to cover actual claim costs, 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 medical plan subscriptions to cover claims expenses, 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 medical plan subscriptions. The assumptions we make about breeds and other factors in pricing medical plan subscriptions may prove to be inaccurate and, accordingly, these pricing analytics may not accurately reflect the claims expense that we will ultimately incur. Furthermore, if any of our competitors developed similar or better data systems, adopted similar or better underwriting criteria and pricing models or received our data, our competitive advantage could decline or be lost.
Our actual claims expenses may exceed our current reserve established for claims and may adversely affect our operating results and financial condition.
Our recorded claims reserve is based on our best estimates of claims, both reported and incurred but not reported, after considering known facts and interpretations of circumstances and the estimated cost to adjudicate those claims. We consider internal factors, including data from our proprietary data analytics platform, experience with similar cases, actual claims paid, historical trends involving claim payment patterns, patterns of claims being received, seasonality patterns, pending levels of unpaid claims, claims management 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 the unpaid portion of claims that have occurred, including claims incurred but not reported, 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 claims and claims administration may vary materially from recorded reserves, and such variance may result in adjustments to the claims reserve, which could have a material effect on our operating results.
We rely significantly on Territory Partners, veterinarians and other third parties, to recommend our medical plan.
We rely significantly on Territory Partners and other third parties to cultivate direct veterinary relationships and build awareness of the benefits that our medical plan offers veterinarians and their clients. In turn, we rely on veterinarians to introduce and refer our medical plan 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 medical plan subscriptions. Veterinary practices represent our largest member acquisition channel, accounting for over 50% of our enrollments and approximately 68% of our enrollments excluding existing members adding pets and referring their friends and family in the nine months ended September 30, 2017.
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 the medical plan we offer;
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 in a medical plan 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 necessarystrategic partners, to generate positive consumer experiences.leads.
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, existing members, online and other businesses, animal shelters, breeders and veterinary affiliates, including veterinarian purchasing groups and associations 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.manage as we grow.
Veterinary leads represent our largest member acquisition channel. We expendspend significant time and resources attracting qualified Territory Partners and providing them with complete and current information about our business. Theirbusiness and they, in turn, communicate the benefits of medical insurance for pets to veterinarians. Our relationship with usour Territory Partners may be terminated at any time (for instance, if they feel unsupported or undervalued by us), and, if terminated, we may not recoup the costs associated with educating them about our medical plansubscription 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 affect 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 costpast or need to maintainin order to implement our relationships with Territory Partners outweighs the benefits provided by Territory Partners, or if they feel unsupported or undervalued by usbusiness strategy and terminate their relationship with us, our growth and financial performance could be adversely affected.
The success ofOur ability to generate leads through veterinary hospitals could be negatively impacted if our relationships with veterinary practices depends on the overall value our medical plan can provide to veterinarians. If the scope of our medical plan coveragepolicy is perceived to be inadequate, or our claims settlement process is unsatisfactory to the veterinarians' clients because, for example, our coverage is insufficient, member requests for reimbursement are denied or we fail to timely settle and pay veterinary invoices, veterinarians may be unwilling to recommend our medical plan to their clients and they may encourage their existing clients who have subscribed to our medical plan to stop subscribing to our medical plan or to purchase a competing product. If veterinarians determine our medical plan 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 impactif our abilityprocess for paying veterinary invoices is unsatisfactory to increase our member base and grow our business.
the veterinarians’ clients.
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 certificateexam day offer 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 contractors;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 the Company.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. In addition, the costs associated with defending, settling, or resolving pending and future lawsuits (including demands for arbitration) relating to the independent contractor status of Territory Partners could be material to our business.
Any of the foregoing circumstances could have a material adverse impact on our operating results and financial condition.
Our member base has grown rapidlyThe prices of our subscriptions are based on assumptions and estimates. If our actual experience differs from the assumptions and estimates used in recent periods,pricing our subscriptions or if we are unable to obtain any necessary regulatory approval for our pricing, our revenue and financial condition could be adversely affected.
The pricing of our subscriptions reflects amounts we expect to pay for a pet’s medical care and we derive these prices from assumptions that we make based on our analytics platform. Our analytics platform draws upon pet data we collect and we use this data to price our policy in response to 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 hospital preferences. 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 ablelost.
The prices of our subscriptions also reflect assumptions and estimates regarding our own operating costs and expenses. We monitor and manage our pricing and overall sales mix to achieve our target returns. If the actual costs, including veterinary invoice expenses, operating costs and expenses within anticipated pricing allowances, are greater than our assumptions and estimates such that the premiums we collect are insufficient to cover these expenses, then our gross profit could be adversely affected and our revenue may be insufficient to maintain profitability. Conversely, if our pricing assumptions differ from actual results such that we overprice risks, our competitiveness and growth prospects could be adversely affected.
In addition, many states have adopted laws or are considering proposed legislation that, among other things, limit the sameability of insurance companies to effect rate increases or to cancel, reduce or not renew existing policies, and many state regulators have the power to reduce, or to disallow increases in premium rates. Most states require licensure and regulatory approval prior to marketing new insurance products. Our practice has been to regularly reevaluate the price of membership growth.our subscriptions, with any pricing changes implemented at least annually, subject to the review and approval of the state regulators, who may reduce or disallow our pricing changes. Such review has often in the past resulted, and may in the future result, in delayed implementation of pricing changes and prevent us from making changes we believe are necessary to achieve our targeted payout ratio, which could adversely affect our operating results and financial condition. If external factors caused veterinary invoice expenses to significantly decrease, the review and approval of our proposed pricing may be impacted. In addition, we may be prevented by regulators from limiting significant pricing changes, requiring us to raise rates more quickly than we otherwise may desire. This could damage our reputation with our members and reduce our retention rates, which could significantly damage our brand, result in the loss of expected revenue and otherwise harm our business, operating results and financial condition.
Our abilityactual 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 growpay, inclusive of an estimate for veterinary invoices we have not yet received, after considering internal factors, including data from our businessproprietary 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 generate revenue depends significantly on attracting new members. Forregulatory requirements and economic conditions. Because reserves are estimates of veterinary invoices that have been incurred but are not yet submitted to us, setting 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.
Rising costs of veterinary care and the nine months ended September 30, 2017,increasing availability and usage of more expensive, technologically advanced medical treatments may increase the amounts of veterinary invoices we generated 90%receive. Increases in the number of our revenueveterinary invoices we receive could arise from medical plan subscriptions. In orderunexpected events that are inherently difficult to continuepredict, 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 increase our membership, we must continue to offer a medical plan that provides superior value to our members. Our ability to continue to grow our membership will also depend in part on the effectiveness of our salestime, and marketing programs. Our member baseshort-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 grow or may decline as a result of increased competition or the maturationpet, the pet’s breed and age (at enrollment) and other factors outside of our business.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.
WeThe ultimate cost of paying veterinary invoices and the related administration may not maintainvary 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 current rateoperating results and resources available for acquiring additional members.
If more veterinary hospitals install and use our patented proprietary software, the number or amounts of revenue growth.veterinary invoices we receive is likely to increase.
Our revenue has increased quicklypatented proprietary software is designed to integrate directly with most software systems used by veterinary hospitals and substantially in recent periods.allow us to receive and pay veterinarian invoices directly. We believe that it is critical to our continued revenue growth will depend on, among other factors,long-term success to improve the member experience so we encourage veterinary hospitals to install and use our ability to:
improvesoftware. We have found that installation and use of 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 medical plan;
maintain positive relationships with andsoftware by a veterinary hospital could increase the number of invoices we receive from that practice. As more veterinary hospitals install our software, we expect the number or amounts of veterinary invoices to increase and efficiency of Territory Partners;
continue to offer a superior value medical plan with competitive features and rates;
accurately price our medical plan subscriptionsresult in relation to actual membership claims costs and operating expenses and achieve required regulatory approval for pricing changes;
provide our members with superior member service, including a timely and efficient claims experience and by recruiting, integrating and retaining skilled and experienced claims personnel who can appropriately and efficiently adjudicate member claims;
generate new and maintain existing relationships and programsan increase 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 awarenesscost of and positive associations with our brand; and
successfully respond to any regulatory matters and defend any litigation.
You should not relyrevenue, which may have a material adverse effect on our historical rate of revenue growth as an indication of our future performance.financial condition.
Our use of capital may be constrained by risk-based capital regulations or contractual obligations.
Our subsidiary, American Pet Insurance Company,APIC, 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, which was $25.8$55.3 million as of December 31, 2016. 2019. We are also subject to a contractual obligation related to our reinsurance agreement with Omega, who writes our policies in Canada. Under this agreement, we are required to fund a Canadian trust account in accordance with Canadian regulations. As of December 31, 2019, the account held CAD $4.3 million.
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 the Company’s reinsurance agreement with Omega General Insurance Company (Omega). Under this agreement, the Company is required to fund a Canadian Trust account in accordance with Canadian regulations. As of December 31, 2016, the account held CAD $2.1 million.
Unexpected increases in the severity or frequency of claims may negatively impact our operating results.
Unexpected changes in the severity or frequency of claims may negatively impact our operating results. Changes in claims severity are driven primarily by inflation in the cost of veterinary care and the increasing availability and usage of expensive, technologically advanced medical treatments. Increases in claims severity also 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 claim frequency from time to time, and short-term trends may not continue over the longer term. The frequency of claims 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 more frequent claims and other new member acquisition activities. A significant increase in claim severity or frequency could increase our cost of revenue and have a material adverse effect on our financial condition.
Changes in the Canadian currency exchange rate may adversely affect our revenue and operating results.
We offer our medical plan in Canada, which exposes us to the risk of changes in the Canadian currency exchange rates. For the nine months ended September 30, 2017, approximately 19% of our total revenue was generated in Canada. 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.
Our success depends on our ability to adjust member claimsreview, process, and pay veterinary invoices timely and accurately.
We mustbelieve member satisfaction depends on our ability to accurately evaluate and timely pay member claimsveterinary invoices in a manner that gives our members high satisfaction.timely manner. Many factors can affect our ability to pay member claims accurately, and in a timely manner that gives our members high satisfaction,do this, including the training, experience and skill of our personnel, our ability to reduce the number of claimspayment requests made for non-covered conditions and ineligible invoice items, the department’s culture and theservices not included in our subscription, effectiveness of its management, our ability to develop or select and implement appropriate procedures, supporting technologies and systems, to support our member claims functions and changes in our policy coverage.and veterinarian compliance with our protocols and procedures. Our failure to pay claim requests fairly,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 claim submissions.veterinary invoices.
It is possible that a member, or a third-party actually or purportedly on behalf of the member, could submit ana 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 claims 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.
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"“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 coverageinsurance for their pets. We are focused primarily on expanding our share of the overall size of the market, and we view our primary competitive challenge as educating pet owners on why our medical plansubscription 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. The largest of these traditional "pet insurance" providers is Nationwide Pet (formerly Veterinary Pet Insurance Company), a division of Nationwide Insurance. They have historically offered a number of traditional policy options and are now offering an additional product that may appear similar to ours.products, such as wellness. In addition, new entrants backed by large insurance companies, such as Marsh, Nationwide, and Geico, have attempted to enter the pet insurance market in the past and may do so again in the future. Further, traditional "pet insurance"“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 offers that are more attractive offers to potential employees, referral sources and third-party service providers.
To compete effectively, we believe we will need to continue to invest significant resources in sales and marketing, in improving theour member service at our contact center and claims department,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, medical plan 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,profitability and the failure to do so could result in loss of existing or potential members, increased sales and marketing expenses or diminisheddiminish our 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 seeking to enroll in our medical plan 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 the medical plan we offer, including its perceived value, coverage, 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 a pet medical plan;
the quality of and changes to the consumer experience, including on our website or with our contact center or claims department;
regulatory requirements, including those that make the experience on our website cumbersome or difficult to navigate or that hinder our call center or claims department’s 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 medical plan on our website or telephonically through 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 realize any benefit from these investments. If the expenses that we incur in connection with these activities do not result in sufficient growth in members to offset the cost, our business, operating results and financial condition will be adversely affected.strength.
If we are unable to maintain and enhance our brand recognition and reputation, our business and operating results will be harmed.
We believe that maintaining and enhancing our brand recognition and reputation is critical to our relationships with existing members, Territory Partners, veterinarians and other referral sources,others, and to our ability to attract new members, new Territory Partners, and additional supportive veterinarians and other referral sources.veterinarians. We also believe that the importance of our brand recognition and reputation will continue to increase as competition in our market continues to develop and mature. Our success in this area will depend on a wide range of factors, some of which are out of our control, including the following:
•the efficacy and viability of our sales and marketing programs;
•the perceived value of our medical plan;subscription;
•the quality of service provided, by our contact center and claims professionals, including the fairness, ease and timeliness of our claims administration process;reviewing and paying veterinary invoices;
•actions of our competitors, Territory Partners, veterinarians and other referral sources;others;
•positive or negative publicity, including regulatory pronouncements and material on the Internet or social media;
•regulatory and other government-related developments; and
•litigation-related developments.
The promotion of our brand maywill require us to make substantial investments, and we anticipate that, as our market becomes increasingly competitive, these branding initiatives may become increasingly difficult and expensive. For instance, we have found that search engine optimization costs have increased as competitors have spent additional funds to promote their products in search results over us. Our brand promotion activities may not be successful or yield increased revenue, and to the extent that these activities result in increased revenue, the increased revenue may not offset the expenses we incur and our operating results could be harmed. If we do not successfully maintain and enhance our brand, our business may not grow and our relationships with veterinarians and other referral sources could be terminated,adversely affected, which would harm our business, operating results and financial condition.
Furthermore, negative publicity, whether or not justified, relating to events or activities attributed to us, our employees, our strategic partners, our affiliates, or others associated with any of these parties, may tarnish our reputation and reduce the value of our brands. Damage to our reputation and loss of brand equity may reduce demand for our services and have an adverse effect on our business, operating results, and financial condition. Moreover, any attempts to rebuild our reputation and restore the value of our brands may be costly and time consuming, and such efforts may not ultimately be successful.
Our business depends on our ability to maintain and scale the infrastructure necessary to operate our technology platform and could be adversely affected by a system failure.
Our business depends on our ability to maintain and scale the infrastructure necessary to operate our technology platform, which includes our analytics and pricing engine, claims management systems for managing veterinary invoice payments, customer relationship management system, billing system, contact center phone system and website. We use these technology frameworks to price our medical plan subscriptions, enroll members, engage with current members and administer member claims under our medical plan. Additionally, ourpay veterinary invoices. Our members review and purchase subscriptions to our medical plan and submit reimbursement requests through our website and contact center.center, and for those veterinary hospitals who have installed our patented proprietary software, we receive and pay veterinarian invoices directly through our software. Our reputation and ability to acquire, retain and serve our members depends on the reliable performance of our technology platform and the underlying network systems and infrastructure, and on providing best-in-class member service, including through our contact center and website. As our member base continues to grow, the amount of information collected and stored on the systems and infrastructure supporting our technology platform will continue to grow, and we expect to require an increasing amount of network capacity, computing power and information technology personnel to develop and maintain our technology platform and service our departments involved in member interaction.
We have made, and expect to continue to make, substantial investments in equipment and related network infrastructure to handle the operational demands on our technology platform, including increasing data collection, software development, traffic on our website and the volume of calls at our contact center. The operation of the systems and infrastructure supporting our technology platform is expensive and complex and could experience operational failures. In the event that our data collection, member base or amount of traffic on these systems grows more quickly than anticipated, we may be required to incur significant additional costs to increase the capacity in our systems. AnyFurther, our development and implementation activities may not be successful, may not be well-received by veterinarians or by new or existing members, particularly if they are costly, cumbersome or unreliable, and we may incur delays or cost overruns or elect to curtail our currently planned expenditures related to them. Even if our system improvements are well-received, they may be or become obsolete due to technological reasons or the availability of alternative solutions in the marketplace. If new solutions and enhancements are not successful on a long-term basis, we may not realize benefits from these investments, and our business and financial condition could be adversely affected.
In addition, any system failure that causes an interruption in or decreases the responsiveness of our services could impair our revenue-generating capabilities, harm our business and operating results and damage our reputation. In addition, any loss or mishandling of data could result in breach of confidence, competitive disadvantage or loss of members, and subject us to potential liability. Any failure of the systems and infrastructure that we rely on could negatively impact our enrollments as well as our relationship with members. If we do not maintain or expand the systems and infrastructure underlying our technology platform successfully, or if we experience operational failures, our reputation could be harmed and we could lose current and potential members, which could harm our operating results and financial condition.
We have made, and expect to continue to make, significant investments in new solutions and enhancements to our technology platform. These new solutions and enhancements may not be successful, and we may not recognize the expected benefits.
We have a team of product and engineering professionals dedicated in part to enhancing our technology platform and developing new solutions. We have made, and expect to continue to make, significant investments in these new solutions and enhancements. For example, we have made significant investments in Trupanion ExpressTM, which is designed to facilitate the direct payment of invoices to veterinary practices. These development and implementation activities may not be successful, and we may incur delays or cost overruns or elect to curtail our currently planned expenditures related to them. Further, if or when these new solutions or enhancements are introduced, they may not be well received by veterinarians or by new or existing members, particularly if they are costly, cumbersome or unreliable. Even if they are well-received, they may be or become obsolete due to technological reasons or to the availability of alternative solutions in the marketplace. If new solutions and enhancements are not successful on a long-term basis, we may not recognize benefits from these investments, and our business and financial condition could be adversely affected.
If we fail to effectively manage our growth, our business, operating results and financial condition may suffer.
We have recently experienced, and expect to continue to experience, significant growth, which has placed, and may continue to place, significant demands on our management and our operational and financial systems and infrastructure. We expect that our growth strategy will require us to commit substantial financial, operational and technical resources. Itresources and this commitment may also result in increased costs, including unexpected increases in our underlying costs (such as member acquisition costs or costs associated with increases in the frequencynumber or severityamounts of claims costs)veterinary invoices received) generated by our new business, which could prevent us from becomingremaining profitable and could impair our ability to compete effectively for pet medical plan business. Additionally, we have in the past, and may in the future, experience increases in medical plan subscription terminations as our membership grows, which negatively affects our retention rate. If we do not effectively manage growth at any time, our financial condition could be harmed and the quality of our services could suffer.
In order to successfully expand our business, we need to hire, integrate and retain highly skilled and motivated employees. We also need toemployees and continue to improve our existing systems for operational and financial management. These improvements could require significant capital expenditures and place increasing demands on our management. We may not be successful in managing or expanding our operations or in maintaining adequate financial and operating systems and controls. If we do not successfully implement improvements in these areas, our business, operating results and financial condition will be harmed.
Emerging claim and coverage issues may adversely affect our business.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge, including new or expanded theories of liability. These or other changes could impose new financial obligations on us by extending coverage beyond our underwriting intent or otherwise require us to make unplanned modifications to the products and services that we provide, or cause the delay or cancellation of products and services that we provide. In some instances, these changes may not become apparent until sometime after we have issued subscriptions that are affected by the changes. As a result, the full extent of liability under our subscriptions may not be known for many years after subscription begins.
Our operating results may vary, which could cause the trading price of our stock to fluctuate or decline, make period-to-period comparisons less meaningful, and make our future results difficult to predict.
We may experience fluctuations in our revenue, expenses and operating results in future periods. Our operating results may fluctuate in the future as a result of a number of factors, many of which are beyond our control. These fluctuations may lead analysts to change their long-term models for valuing our common stock, cause us to face short-term liquidity issues, impact our ability to retain or attract key personnel or cause other unanticipated issues, all of which could result in declines in our stock price. Moreover, these fluctuations may make comparing our operating results on a period-to-period basis less meaningful and make our future results difficult to predict. You should not rely on our past results as an indication of our future performance. In addition, if revenue levels do not meet our expectations, our operating results and ability to execute on our business plan are likely to be harmed. In addition to the other factors listed in this “Risk Factors” section, factors that could affect our operating results include the following:
our ability to retain our current members and grow our member base;
the level of operating expense we elect to incur related to sales and marketing and technology and development initiatives that are discretionary in nature;
the effectiveness of our sales and marketing programs;
our ability to improve veterinarians’ and other third-parties’ willingness to recommend our medical plan;
the timing, volume and severity of our claims and the adequacy of our claims reserve;
our ability to accurately price our medical plans and achieve required regulatory pricing approvals;
regulatory limitations or other constraints on our ability or our willingness to implement pricing changes;
the level of demand for and the cost of our medical plan subscriptions or those of our competitors;
fluctuations in applicable foreign currency exchange rates;
the perceived value of our medical plan to veterinarians and pet owners;
spending decisions by our members and prospective members;
our costs and expenses, including pet acquisition costs and claims expenses;
our ability to expand the scope and efficiency of our Territory Partner network;
our ability to effectively manage our growth;
the effects of increased competition in our business;
our ability to keep pace with changes in technology and our competitors;
the impact of any security incidents or service interruptions;
costs associated with defending any regulatory action or litigation or with enforcing our intellectual property, contractual or other rights;
the impact of economic conditions on our revenue and expenses; and
changes in government regulation affecting our business.
Seasonal or periodic variations in the behavior of our members also may cause fluctuations in our financial results. Enrollment in our medical plansubscription tends to be discretionary in nature and may be sporadic, reflecting overall economic conditions, budgeting constraints, pet-buying patterns and a variety of other factors, many of which are outside our control. For example, we expect to experiencehave experienced some effects of seasonal trends in visits to veterinarians in the fourth quarter and in the beginning of the first quarter of each year in connection with the traditional holiday season. While we believe seasonal trends have affected and will continue to affect our quarterly results, our growth may have overshadowed these effects to date. We believe that our business will continue to be subject to seasonality in the future, which may result in fluctuations in our financial results.
Due to these and other factors, our financial results for any quarterly or annual period may not meet our expectations or the expectations of investors or analysts that follow our stock and may not be meaningful indications of our future performance.
Mergers or other strategic transactions involving our competitors could weaken our competitive position, which could adversely affect our ability to compete effectively and harm our results of operations.
Our vertical integrationindustry is highly fragmented, and we believe it is likely that some of our existing competitors will consolidate or be acquired. In addition, some of our competitors may enter into new alliances with each other or may establish or strengthen cooperative relationships with systems integrators, third-party consulting firms or other parties. Any such consolidation, acquisition, alliance or cooperative relationship could adversely affect our ability to compete effectively and lead to pricing pressure and our loss of market share and could result in higher costs.
We managea competitor with greater financial, technical, marketing, service and other resources, all aspects of which could harm our business, including writing our medical plan, implementing our own national independent referral networkfinancial condition, cash flows and results of Territory Partners, pricing our medical plan subscriptions with our in-house actuarial team, administering claims made with respect to our medical plan, operating our own contact center and owning our own brand. While we believe this vertically integrated approach reduces frictional costs and enhances members' experiences, third-party providers may, now or in the future, be able to replicate this model, partially or entirely, on a more efficient and effective basis. If our in-house services are or become less efficient or less effective than the same services provided by a third party, we may not realize the related cost savings and may be unable to provide a superior membership experience, which may have an adverse effect on our operating results.
Our forecasts of market growth may prove to be inaccurate, and even if the market for medical coverage for cats and dogs in North America achieves the forecasted growth, our business may not grow at similar rates, if at all.
Growth forecasts are subject to significant uncertainty and are based on assumptions and estimates, which may not prove to be accurate. Although we believe that the North American market for pet medical coverage will grow over time if consumers are offered a high-value product, the market for medical coverage for cats and dogs in North America has been historically growing slowly or stagnant and may not be capable of growing further. Even if this market experiences significant growth, we may not grow our business at similar rates, or at all. For example, the market for medical coverage for cats and dogs in North America has been highly competitive and may become even more competitive in the future. Our growth is subject to many factors, including our success in implementing our business strategy and maintaining our position in a highly competitive market, which are subject to many risks and uncertainties.
operations.
We depend on key personnel to operate our business and, if we are unable to retain, attract and integrate qualified personnel, our ability to develop and successfully grow our business could be harmed.
Our success depends to a significant extent on the continued services of our current management team, including Darryl Rawlings, our founder and Chief Executive Officer. The loss of Mr. Rawlings or several other key executives or employees within a short time frame could have a material adverse effect on our business. We employ all of our executive officers and key employees on an at-will basis, and their employment can be terminated by us or them at any time, for any reason and without notice, subject, in certain cases, to severance payment rights. In order to retain valuable employees, in addition to salary and cash incentives, we have provided stock options and restricted stock that vest over time and may in the future grant equity awards tied to company performance. The value to employees of stock options and restricted stock that vest over time will be significantly affected by movements in our stock price that are beyond our control and may at any time be insufficient to maintain their retention benefit or counteract offers from other companies. We would be adversely affected if we fail to adequately plan for the succession of our senior management and other key employees. Additionally, if we were to lose a large percentage of our current employees in a relatively short time period, or our employees were to engage in a work stoppage or unionize, we may be unable to hire and train new employees quickly enough to prevent disruptions in our operations, which may result in the loss of members, Territory Partners or referral sources.
Our success also depends on our ability to attract, retain and motivate additional skilled management personnel. We plan to continue to expand our work force, which we believe will enhance our business and operating results. We believe that there is significant competition for qualified personnel with the skills and knowledge that we require. Many of the other companies with which we compete for qualified personnel have greater financial and other resources than we do. They also may provide more diverse opportunities and better chances for career advancement. Some of these characteristics may be more appealing to high-quality candidates than those we have to offer. If we are unable to attract and retain the necessary qualified personnel to accomplish our business objectives, we may experience constraints that will significantly impede the achievement of our business objectives and our ability to pursue our business strategy. New hires require significant training and, in most cases, take significant time before they achieve full productivity. New employees may not become as productive as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals. If
We may continue to create, invest in or acquire businesses, products and technologies, which could divert our recruiting, trainingmanagement’s attention, result in additional dilution to our stockholders, otherwise disrupt our operations or harm our operating results.
We have in the past created, invested in or acquired complementary businesses, products, technologies and retentionnew lines of business, and we may continue to do so in the future. Our ability to successfully evaluate and manage investment opportunities, or make and integrate acquisitions or products, is unproven. For example, we have invested in a pet food initiative, and we believe that pet food may be an important part of our offerings over the long term. We do not have experience manufacturing, selling, or distributing food products and pet food manufacturing facilities, and pet food products are subject to many laws and regulations administered by the United States Department of Agriculture, the Federal Food and Drug Administration, the Occupational Safety and Health Administration, and other federal, state, local, and foreign governmental agencies relating to the production, packaging, labelling, storage, distribution, quality, and safety of food products and the health and safety of employees. We have also recently acquired technology intended to enable us to improve our back-end software and facilitate certain expansion efforts, but technology integration is complicated, expensive and time consuming, and it may not result in us realizing the intended benefits from the acquisition.
The pursuit of potential new products, investments or acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable opportunities, whether or not they are consummated. Further, even if we successfully invest in or acquire additional businesses or technologies, we may not achieve the anticipated benefits from the transaction. The investment or acquisition may also expose us to additional risks, including from unknowingly inheriting liabilities that are not successfuladequately covered by indemnities. Acquisitions or do not generate a corresponding increaseinvestments could also result in revenue,dilutive issuances of equity securities or the incurrence of debt, which could adversely affect our business will be harmed.operating results.
If we cannot maintaindo not spend our corporate culture asdevelopment budget efficiently or effectively on commercially successful and innovative offerings and products, we grow,may not realize the expected benefits of our strategy. Further, our development efforts with respect to new products and offerings could distract management from current operations, and will divert capital and other resources from our more established products and offerings. If an investment or acquisition fails to meet our expectations, our business, operating results and financial condition may suffer.
We may not realize the benefits of our current and planned transactions with Aflac.
In October 2020, we could loseentered into an Strategic Alliance Agreement, a Stock Purchase Agreement and a Shareholder Agreement with Aflac. Aflac has purchased $60.0 million and has agreed to purchase an additional $140.0 million following the innovation, teamwork and focus that contribute crucially to our business.
Our culture is fundamental to our success and defines who we are and how we operate our business. We were founded on a deep appreciationexpiration or termination of the special relationship between pet owners, their beloved petsantitrust waiting period and their trusted veterinarians. Wesubject to certain other terms and conditions. These closing conditions may not be satisfied, in which event the second closing would not occur, the contractual three-year holding period would not apply to the shares we have invested substantial time, energyalready sold to Aflac, and resources in developing a culture that fosters teamwork, innovation, creativityAflac may terminate the Alliance.
The Strategic Alliance Agreement sets forth the structure for the Alliance, including its intended benefits to us relating to brand, access and a focus on providing value for our membersdistribution as well as for Territory Partnersgo-to-market matters. We and veterinarians. As we develop our infrastructure while we grow,Aflac have agreed to negotiate in good faith and to act reasonably with each other in order to agree on such terms as are necessary to fully implement the Alliance. However, we may find it difficultbe unable to maintain these valuable aspectsestablish the terms for and implement the Alliance and, as a result, we may not realize the intended benefits of the Alliance. In addition, we have agreed not to develop with a third party any worksite employee benefit regarding its pet insurance in the United States or Japan and to work exclusively with Aflac to develop opportunities in Japan’s pet insurance marketplace, which may prevent us from pursuing alternative opportunities. If we are unable to implement the terms of the Alliance, Aflac's obligations in the Shareholder Agreement, including standstill obligations and contractual holding period requirements, would terminate, which may have an adverse effect on our corporate culture. Any failurestock price and otherwise cause our business to preserve our culture could negatively impact our future success, including our ability to attract and retain personnel, encourage innovation and teamwork and effectively focus on and pursue our corporate objectives.suffer.
We depend on relationships with strategic partners, and our inability to maintain our existing and secure new relationships with strategic partners could harm our revenue and operating results.
A portion of our enrollment leads arerevenue is attributable to a variety of different types of strategic partnership arrangements. These partnerships involve various risks, depending on their structure, including the following:
•we may be unable to maintain or secure favorable relationships with strategic partners;
•our strategic partners may not be successful in creating leads;
•we may be unable to convert leads from our strategic partners into enrolled pets;
•our strategic partners could terminate their relationships with us;
•our strategic partners may acquire or form alliances with our competitors, thereby reducing their business with us;
•we may not experience a consistent correlation between revenues and expenditures related to the partnership,partnership; and
•bad publicity and other issues faced by our strategic partners could negatively impact us.
Any inability to secure, maintain or effectively manage these complicated relationships with strategic partners could have a material adverse effect on our revenue and operating results.
Our business and financial condition is subject to risks related to our writing of policies pursuant to contractual relationships with unaffiliated third parties.
Our other business segment generally includes revenues and expenses involving contractual relationships with unaffiliated third parties and related marketing to enterprises. We have relatively limited experience in writing policies for unaffiliated third parties. This business is not expected to grow at the same rate as our core business and may decline. Changes to this business may be volatile due to the nature of the relationships. Further, this business historically has had, and we expect it to continue to have, lower margins than our core business. As a result of this line of business, we are subject to additional regulatory requirements and scrutiny, which increase our costs and risks, and may have an adverse effect on our operations. Further, administration of this business and any similar business in the future may divert our time and attention away from our core business, which could adversely affect our operating results in the aggregate.
For example, we have writtenthe pet insurance policies we write for general agents since 2012. These policies provide different coverage and are subject to materially different terms and conditions than the Trupanion medical plan. Further, the unaffiliatedour subscription. They are typically annual policies with monthly payment terms, which can result in accounts receivable balances and payment timing patterns we do not experience in our subscription business. The relationships with these general agents administer these policies and market them to consumers. For the nine months ended September 30, 2017, premiums from these policies accounted for 7.5% of our total revenue. These relationships canmay be terminated by either party and, if terminated, would result in a reduction in our revenue to the extent we cannot enter other relationships and generate equivalent revenuesrevenue with different general agents. In addition,For the year ended December 31, 2019, premiums from policies sourced by general agents control trust accounts they maintain onaccounted for 14% of our behalf.total revenue, and one general agent sourced members whose premiums accounted for over 10% of our total revenue. Further, the unaffiliated general agents administer these policies and market them to consumers. If the general agents make operating decisions that adversely affect its business or brand, our business or brand could also be adversely affected.
In Canada, our medical plan is written by Omega General Insurance Company. If Omega were to terminate its underwriting arrangement with us, our business could be adversely affected.
In Canada, our medical planpet insurance subscription is written by Omega, and we assume all premiums written by Omega and the related claimsveterinary invoice expense through an agency agreement and a fronting and administration agreement. These agreements may be terminated by either party with one year’s prior written notice. If Omega were to terminate our agreement or be unable to write insurance for regulatory or other reasons, we may have to terminate subscriptions with our existing Canadian members, or suspend member enrollment and renewals in Canada until we enteredenter into a relationship with another third party to write our medical plan,subscription or we set up an entity able to perform this service, which may take a significant amount of time and require significant expense. We may not be able to enter into a new relationship, and any new relationship would likely be on less favorable terms. Any delay in entry into a new relationship or suspension of member enrollment and renewals could have a material adverse effect on our operating results and financial condition.
Changes in the foreign exchange rates may adversely affect our revenue and operating results.
We offer our subscription in Canada and in the future may offer it in other countries, which exposes us to the risk of changes in currency exchange rates. For the year ended December 31, 2019, approximately 18% of our total revenue was generated in Canada. Fluctuations in the relative strength of the US dollar has in the past and could in the future adversely affect our revenue and operating results.
We may decide to set up multiple insurance subsidiaries, which may complicate our business and harm our results of operations.
Currently, APIC, our wholly owned subsidiary, underwrites memberships for our U.S. subscription product, and Omega, a third party, underwrites memberships for our Canadian subscription product. We are in the process of setting up additional wholly owned insurance companies in the U.S. and Canada to underwrite our subscription and in the future we may decide to set up and operate additional wholly-owned insurance companies in the U.S., Canada or a different country. The pursuit of acquiring or forming a new insurance subsidiary may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable opportunities, whether or not the formation or acquisition is completed. Further, even if we are successful in forming or acquiring a new insurance subsidiary we may not achieve the anticipated benefits. In addition, we may require additional capital to meet our risk-based capital requirements for the new insurance subsidiaries and will be subject to additional regulatory scrutiny in the jurisdiction of incorporation and any additional jurisdictions the insurance subsidiary operates. Failure to comply with laws, regulations and guidelines applicable to a new insurance subsidiary could result in significant liability, result in the loss of revenue and otherwise harm our business, operating results and financial condition.
If we are unable to implement and maintain effective internal control over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock may be negatively affected.
We are required to maintain internal control over financial reporting and to report any material weaknesses in such internal control. Section 404 of the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act) requires that we evaluate and determine the effectiveness of our internal control over financial reporting and provide a management report on the internal control over financial reporting, which must be attested to by our independent registered public accounting firm to the extent we no longer qualify for the exemption provided to an emerging growth company, as defined by The Jumpstart Our Business Startups Act of 2012 (JOBS Act).firm.
We may not detect errors on a timely basis and our financial statements may be materially misstated. We have had in the past, and may have in the future, material weaknesses and significant deficiencies in our internal control over financial reporting. If
we or our independent registered public accounting firm identify future material weaknesses in our internal control over financial reporting, we are unable to comply with the requirements of Section 404 in a timely manner, we are unable to assert that our internal control over financial reporting is effective or our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be negatively affected. We could also become subject to investigations by the stock exchange on which our securities are listed, the SEC or other regulatory authorities, which could require additional financial and management resources.
If our security measures are breached and unauthorized access is obtained to our data, including our members’ data, we may lose our competitive advantage, our systems may be perceived as not being secure and we may incur third-party liability.
Our data repository contains proprietary information that we believe gives us a competitive advantage, including claims data on veterinary invoices received and other data with respect to members, Territory Partners, veterinarians and other third parties. We also collect and utilize demographic and other information from and about our members when they visit our website, call our contact center and apply for enrollment. Further, we use tracking technologies, including “cookies,” to help us manage and track our members’ interactions and deliver relevant advice and advertising. Security breaches could expose us to a risk of loss of our data and/or disclosure of this data, either publicly or to a third party who could use the information to gain a competitive advantage. Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or implement adequate preventative measures. In the event of a loss of our systems or data, we could experience increased costs, or delays, legal liability and reputational harm, which in turn may harm our financial condition, damage our brand and result in the loss of members. Such a disclosure also could lead to litigation and possible liability.
In the course of operating our business, we may store and/or transmit our members’ confidential information, including credit card and bank account numbers and other private information. SecurityBecause the methods used to obtain unauthorized access to private information change frequently and may be difficult to detect for long periods of time, security breaches couldwould expose us to a risk of loss of this information, litigation and possible liability. Our payment services may beare similarly susceptible to credit card and other payment fraud schemes, including unauthorized use of credit cards, debit cards or bank account information, identity theft or merchant fraud.
If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise, and, as a result, someone obtains unauthorized access to our data, including data of our members, our reputation may be damaged, our business may suffer and we could incur significant liability. Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or implement adequate preventative measures. If an actual or perceived breach of our security occurs, the public perception of the effectiveness of our security measures could be harmed and weharmed.
In addition, cyber-attacks or acts of terrorism could lose members, which would adversely affect our business.
Any legal liability, regulatory penalties or negative publicity we encounter, including based on the information on our website or that we otherwise distribute or provide, directly or through Territory Partners or other referral sources, could harmcause disruptions in our business operating resultsor the economy as a whole. Our servers and financial condition.
Any legal disputessystems may also be vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems, which could lead to interruptions, delays, loss of critical data or regulatory penalties involving usthe unauthorized disclosure of confidential member data. We currently have limited disaster recovery capability, and our business interruption insurance may be publicly announced,insufficient to compensate us for losses that may occur. Such disruptions could negatively impact our ability to run our business, which could materially harm our reputation and adversely affect our business. We also provide informationhave an adverse effect on our website, through our contact center and in other ways regarding pet health, the pet insurance industry in general and our medical plan, including information relating to subscription fees, coverage, benefits, exclusions, limitations, availability and medical plan comparisons. A significant amount of both automated and manual effort is required to maintain the medical plan information on our website. Separately, from time to time, we use the information provided on our website and otherwise collected by us to publish reports designed to educate consumers. For example, we produce a significant amount of marketing materials regarding our medical plan. If the information we provide on our website, through our contact centers or otherwise is not accurate or is construed as misleading, or if we improperly assist individuals in purchasing subscriptions to our medical plan, our members, competitors or others could attempt to hold us liable for damages, our relationships with veterinarians and other referral sources could be terminated and regulators could attempt to subject us to penalties, revoke our licenses to transact business in one or more jurisdictions or compromise the status of our licenses to transact our business in other jurisdictions, which could result in our loss of revenue. In the ordinary course of operating our business, we may receive complaints that the information we provided was not accurate or was misleading. These types of claims could be time-consuming and expensive to defend, could divert our management’s attention and other resources and could cause a loss of confidence in our business. As a result, whether or not we are able to successfully resolve these claims, they could harm our business, operating results and financial condition.
We are subject to a number of risks related to accepting automatic fund transfers and credit card and debit card payments.
We accept payments of subscription fees from our members through automatic fund transfers and credit and debit card transactions. For credit and debit card payments, we pay interchange and other fees, which may increase over time. An increase in the number of members who utilize credit and debit cards to pay their subscription fees or related credit and debit card fees would reduce our margins and could require us to increase the subscription fees, for our medical plan, which could cause us to lose members and revenue, or suffer an increase in our operating expenses, either of which could adversely affect our operating results.
If we, or any of our processing vendors or banks have problems with our billing software, or if the billing software malfunctions, it could have an adverse effect on our member satisfaction and could cause one or more of the major credit card companies or banks to disallow our continued use of their payment products. In addition, if our billing software fails to work properly and, as a result, we do not automatically charge our members’ credit cards on a timely basis or at all, or a bank withdraws the incorrect amount or fails to timely transfer the correct amount to us, we could lose revenue and harm our member experience, which could adversely affect our business and operating results. Moreover, a vendor could fail to process payments, or could process payments in the wrong amounts, which could result in us failing to collect premiums, could result in increased cancellations and could adversely affect our reputation.
We are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, including the Payment Card Industry Data Security Standard (PCI DSS), a security standard applicable to companies that collect, store or transmit certain data regarding credit and debit cards, holders and transactions. InAlthough we are currently compliant with PCI DSS, in the past we may not have been, we currently arewere not, and in the future we may not be, fully or materially compliant with PCI DSS.DSS, or other payment card operating rules. Any failure to comply fully or materially with the PCI DSS now or at any point in the future may violate payment card association operating rules, federal and state laws and regulations, and the terms of our contracts with payment processors and merchant banks. Such failure to comply fully or materially also may subject us to fines, penalties, damages and civil liability, and may result in the loss of our ability to accept credit and debit card payments. In addition, there is no guarantee that PCI DSS compliance if we are able to become compliant, will prevent illegal or improper use of our payment systems or the theft, loss or misuse of data pertaining to credit and debit cards, credit and debit card holders and credit and debit card transactions.
If we fail to adequately control fraudulent credit card transactions, we may face civil liability, diminished public perception of our security measures and significantly higher credit card-related costs, each of which could adversely affect our business, operating results and financial condition.
If we are unable to maintain our chargeback rate at acceptable levels, our credit card fees for chargeback transactions, or our fees for many or all categories of credit and debit card transactions, credit card companies and debit card issuers may increase our fees or terminate their relationship with us. Any increases in our credit card and debit card fees could adversely affect our operating results, particularly if we elect not to raise our subscription fees. The termination of our ability to process payments on any major credit or debit card would significantly impair our ability to operate our business.
We have limited experience owning an office building and may face unexpected costs.
In August 2018, we purchased our home office building. Prior to this purchase, we had no experience owning an office building. It is difficult to predict all costs associated with maintaining the building and ensuring it is suitable for our use and that of other tenants and maintain compliance with all environmental and other regulations applicable to ownership of real estate. It is possible that the other current tenants in the building may cease to rent space in the building, which would decrease rental income we expect to receive from them. We recently learned that one tenant has decided not to continue leasing space in the building and we are evaluating use of the newly vacant space. Tenants may also negotiate tenant improvements, requiring capital expenditures that may adversely impact our financial position. In addition, we may identify structural defects or other conditions, or we may determine that remodeling or renovations are necessary given our business operations and objectives. Managing tenants, maintaining the building, and otherwise facing the costs and responsibilities of being the owner of a building may be a distraction from our core business and cause our performance to suffer.
Failure to adequately protect our intellectual property could substantially harm our business and operating results.
We rely on a combination of intellectual property rights, including trade secrets, patents, copyrights, trademarks and domain names, as well as contractual restrictions, to establish and protect our patented proprietary software and our intellectual property. As of September 30, 2017, we had two pending patent applications and one issued patent in the United States, two pending patent applications in Canada, one pending patent application in Brazil, one pending patent application in Japan, one pending patent application in China, one pending patent application in Hong Kong, two pending patents filed under the Patent Cooperation Treaty, and one pending patent application and one issued patent in Europe. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy our digital content, pricing analytics, technology, software, branding and functionality, or obtain and use information that we consider proprietary. Moreover, policing our proprietary rights is difficult and may not always be effective. If we continue to expand internationally, we may need to enforce our rights under the laws of countries that do not protect proprietary rights to as great an extent as do the laws of the United States, which may be expensive and divert management’s attention away from other operations.
Our digital content is not protected by any registered copyrights or other registered intellectual property. Rather, our digital contentproprietary software is protected by statutory and common law rights, user agreements that limit access to and use of our data and by technological measures. Compliance with use restrictions is difficult to monitor, and our proprietary rights in our digital content databases may be more difficult to enforce than other forms of intellectual property rights.
As of September 30, 2017, we had ten registered trademarks in the United States, including “Trupanion”. We had one registered trademark in Canada, and four pending trademarks. Many of our unregistered trademarks, however, contain words or terms having a common usage and, as a result,patents. These patents may not be protectable under applicable law. Trademark protection may alsosufficient to maintain effective product exclusivity because patent rights are limited in time and do not be available,always provide effective protection. Furthermore, our efforts to enforce or sought by us, in every country in which our medical plan may become available. Competitors may adopt names similar to ours, or purchase our trademarks and confusingly similar terms as keywords in Internet search engine advertising programs, thereby impeding our ability to build brand identity and possibly confusing members. Moreover, there could be potential trade name or trademark infringement claims brought by owners of other registered trademarks or trademarks that incorporate marks similar to our trademarks.
We may take action, including initiating litigation, to protect our intellectual propertypatent rights may be ineffective, could result in substantial costs and diversion of resources, could result in the integrityinvalidation of our brand,patent rights, and these efforts may prove costly, ineffective and increase the likelihood of counterclaims against us.
We currently hold the “Trupanion.com” Internet domain name and numerous other related domain names. Domain names generally are regulated by Internet regulatory bodies. If we lose the ability to use a domain name in the United States, Canada or any other country, we may be forced to acquire domain names at significant cost or, in the alternative, be forced to incur significant additional expenses to market our medical plan, including the development of a new brand and the creation of new promotional materials, which could substantially harm our business and operating results. The regulationEven where our patents rights are enforced, legal remedies available for harm caused to us by infringing products may be inadequate to make us whole. Further, our successful assertion of domain namesour patent against one competing product is not necessarily predictive of our future success or failure in asserting the same patent against a second competing product. In addition, patents have a limited lifespan. In the United States, Canadathe natural expiration of a patent is generally 20 years after it is filed. Various extensions may be available. However, the life of a patent, and in other foreign countriesthe protection it affords, is subject to change. Regulatory bodies could establish additional top-level domains, appoint additional domain name registrars or modifylimited. Once the requirementspatent life has expired for holding domain names. As a result, we may notour software, our competitors will be able to acquire or maintain the domain names that utilize the “Trupanion” name in all of the countries in which we currently intend to conduct business.use our patented technology.
We seek to control access to our proprietary technology, software and documentation by entering into confidentiality and invention assignment agreements with our employees and partners, confidentiality agreements or license agreements with third parties, such as service providers, vendors, individuals and entities that may be exploring a business relationship with us, and terms of use with third parties, such as veterinary hospitals desiring to use our technology, software and documentation. These agreements may not prevent disclosure of intellectual property, trade secrets and/or other confidential information, and may not provide an adequate remedy in the event of misappropriation of trade secrets or any unauthorized disclosure of trade secrets and other confidential information. In addition, others may independently discover trade secrets and confidential information and, in such cases, we may not be able to assert any trade secret rights against such parties. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our intellectual property rights and related confidentiality, license and nondisclosure provisions, and failure to obtain or maintain trade secret protection, or our competitors being able to obtain our trade secrets or to independently develop technology similar to ours or competing technologies, could adversely affect our competitive business position.
Litigation or proceedings before the U.S. Patent and Trademark Office or other governmental authorities and administrative bodies in the United States and abroad may be necessary in the future to enforce our intellectual property rights, to protect our domain names and to determine the validity and scope of the proprietary rights of others. Our efforts to enforce or protect our proprietary rights may be ineffective, could result in substantial costs and diversion of resources and could substantially harm our operating results.
Assertions by third parties of infringement or other violation by us of their intellectual property rights could result in significant costs and substantially harm our business and operating results.
Third parties have in the past and may in the future claim that our services or technologies infringe or otherwise violate their intellectual property rights. We may be subject to legal proceedings and claims, including claims of alleged infringement by us of the intellectual property rights of third parties. Any dispute or litigation regarding intellectual property could be expensive and time consuming, regardless of the merits of any claim, and could divert our management and key personnel from our operations.
If we were to discover or be notified that our services potentially infringe or otherwise violate the intellectual property rights of others, we may need to obtain licenses from these parties in order to avoid infringement. We may not be able to obtain the necessary licenses on acceptable terms, or at all, and any such license may substantially restrict our use of the intellectual property. Moreover, if we are sued for infringement and lose the lawsuit, we could be required to pay substantial damages or be enjoined from offering the infringing services. Any of the foregoing could cause us to incur significant costs and prevent us from selling or properly administering subscriptions to our medical plan or performing under our other contractual relationships.
We rely on third parties to provide intellectual property and technology necessary for the operation of our business.
We utilize intellectual property and technology owned and/or hosted by third parties in developing and operating our technology platform and operating our business. From time to time, we may be required to renegotiate with these third parties or negotiate with other third parties to include or continue using their intellectual property or technology in our existing technology platform or business operations or in modifications or enhancements to our technology platform or business operations. We may not be able to obtain the necessary rights from these third parties on commercially reasonable terms, or at all, and the third-party intellectual property and technology we use or desire to use may not be appropriately supported, maintained or enhanced by the third parties. If we are unable to obtain the rights necessary to use or continue to use third-party intellectual property and technology in our operations, or if those third parties are unable to support, maintain and enhance their intellectual property and technology, we could experience increased costs or delays, which in turn may harm our financial condition, damage our brand and result in the loss of members.
Our technology platform and our data are also hosted by a third-party service provider. The terms under which such third-party service provider provides us services may change and we may be required to renegotiate with that third party. If we are unable to renegotiate satisfactory terms, we may not be able to transition to an alternative service provider without interrupting the availability of our technology platform and any interruption could materially and adversely affect our business. Additionally, if our third-party service provider experiences any disruptions, outages or catastrophes, or if it ceases to conduct business for any reason, we could experience an interruption in our business, which in turn may damage our brand, result in a loss of members and harm our financial condition.
The outcome of litigation or regulatory proceedings could subject us to significant monetary damages, restrict our ability to conduct our business, harm our reputation and otherwise negatively impact our business.
From time to time, we have been, and in the future may become, subject to litigation, claims and regulatory proceedings and inquiries, including market conduct examinations and investigations by state insurance regulatory agencies and threatened or filed lawsuits by, among others, government agencies, employees, competitors, current or former customers,members, or business partners.
We cannot predict the outcome of these actions or proceedings, and the cost of defending such actions or proceedings could be material. Further, defending such actions or proceedings could divert our management and key personnel from our business operations. If we are found liable in any action or proceeding, we may have to pay substantial damages or fines, or change the way we conduct our business, either of which may have a material adverse effect on our business, operating results, financial condition and prospects. More critically, an adverse result from a proceeding could require us to change the way we conduct our business, including our marketing and promotional practices, and such a result may have a greater adverse effect on our business than monetary damages or fines. There may also be negative publicity associated with litigation or regulatory proceedings that could harm our reputation or decrease acceptance of our services. These claims may be costly to defend and may result in assessment of damages, adverse tax consequences and harm to our reputation.
Covenants in the credit agreement governing our revolving line of credit may restrict our operations, and if we do not effectively manage our business to comply with these covenants, our financial condition could be adversely affected.
The credit agreement governing our revolving line of credit contains various restrictive covenants, including restrictions on our ability to dispose of our assets, change the name, location, office or executive management of our business, merge with or acquire other entities, incur other indebtedness, incur encumbrances, pay dividends or make distributions to holders of our capital stock, make investments, and engage in transactions with our affiliates, permit withdrawals from APIC (with certain exceptions) and conduct operations in certain of our Canadian subsidiaries.affiliates. Our credit agreement also contains certain financial covenants, including having APIC maintain statutory capital and surplus at all times of not less than the greater of the amount required by APIC or 110% of the highest amount of statutory capital and surplus required in any state in which APIC is licensed; 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; maintaining all of our depository and operating accounts at PWB and/or WAB; maintaining certain investment accounts at PWB and/or PWB affiliates; achieving certain quarterly revenue levels and claims ratio thresholds; maintaining greater than negative $1.0 million net total of operating cash flow and capital expenditures quarterly, and remaining within certain monthly maximum EBITDA loss levels. EBITDA is defined as earnings, plus an amount equal to the sum of (i) tax, plus (ii) depreciation and amortization, plus (iii) interest and non-cash expenses, plus (iv) any non-cash stock-based compensation expense, plus (v) (gain)/loss from equity method investments.covenants. Our ability to meet these restrictive covenants can be affected by events beyond our control, and we have been in the past, and may be in the future, unable to do so. In addition, our failure to maintain effective internal controls to measure compliance with our financial covenants could affect our ability to take corrective actions on a timely basis and could result in our being in breach of these covenants.control. Our credit agreement provides that our breach or failure to satisfy certain covenants constitutes an event of default. Upon the occurrence of an event of default, our lenders could elect to declare any future amounts outstanding under our credit agreement to be immediately due and payable. If we are unable to repay those amounts, our financial condition could be adversely affected.
Any indebtedness we incur could adversely affect our business and limit our ability to expand our business or respond to changes, and we may be unable to generate sufficient cash flow to satisfy any of our debt service obligations.
As of September 30, 2017,December 31, 2019, we had $7.5$26.2 million outstanding indebtedness under our revolving line of credit. Wecredit and may incur indebtedness in the future, including any additional borrowings available under our revolving line of credit. Any substantial indebtedness, and the fact that a substantial portion of our cash flow from operating activities could be needed to make payments on this indebtedness, could have adverse consequences, including the following:
•reducing the availability of our cash flow for our operations, capital expenditures, future business opportunities and other purposes;
•limiting our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate, which could place us at a competitive disadvantage compared to our competitors that may have less debt;
•limiting our ability to borrow additional funds; and
•increasing our vulnerability to general adverse economic and industry conditions.
Our ability to borrow any funds needed to operate and expand our business will depend in part on our ability to generate cash. Our ability to generate cash is subject to the performance of our business, as well as general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We may also need to use operating funds to support risk-based capital requirements and borrow additional funds to support our growth. If our business does not generate sufficient cash flow from operating activities or if future borrowings, are not available to us, under our revolving credit facility or otherwise, are not available to us in amounts sufficient to enable us to fund our liquidity needs, our operating results, financial condition and ability to expand our business and meet our risk-based capital requirements may be adversely affected.
Our financial resultsWe may be negatively affected if we are required to pay incomehave additional tax premium tax, transaction tax or other taxes in jurisdictions where we are currently not collecting and reporting tax.liabilities.
We currently payare subject to income tax, premium tax, transaction tax and other taxes in certainthe U.S. and foreign jurisdictions. Judgment is required in determining our provision for income taxes, premium tax, transaction tax and other taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Further, we often make elections for tax purposes which may ultimately not be upheld. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation in the jurisdictions where we are subject to taxation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on our consolidated financial statements in the period or periods in which that determination is made.
Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.
As of December 31, 2019, we do business. A successful assertion by one or more jurisdictionshad U.S. federal net operating loss carryforwards of approximately $130.3 million that we shouldwill begin to expire in 2027. Under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (the Code), if a corporation undergoes an “ownership change,” the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes, such as research tax credits, to offset its post-change income taxes may be paying income, premium, transaction or other taxes on our income or in connection with enrollmentlimited. In general, an “ownership change” occurs if there is a cumulative change in our medical plan or intercompany services, or the enactment of new laws requiring the payment of income, premium, transfer or other taxes in connection with our business operations, including enrollment in our medical plan or intercompany services, could result in substantialownership by “5-percent stockholders” that exceeds 50 percentage points over a rolling three-year period. Similar rules may apply under state tax liabilities. Our voluntary disclosure of tax obligationslaws. Pursuant to Sections 382 and any future assertions by any jurisdiction that we should be paying taxes may create increased administrative burdens or costs, require payment of substantial fines and penalties, discourage consumers from enrolling in our medical plan, reduce our operational efficiencies, decrease our ability to compete or otherwise substantially harm our business and operating results.
If consumer acceptance383 of the Internet as an acceptable marketplace for a pet medical plan does not continue to increase,Code, annual use of our growth prospects will be harmed.
Our success depends in part on widespread consumer acceptance of the Internet as a marketplace for the purchase of a pet medical plan. Internet use may not continue to develop at historical rates,net operating loss carryforwards and consumers may not continue to use the Internet to research, select and purchase a pet medical plan. In addition, the Internet may not be accepted as a viable resource for a number of reasons, including lack of security of information or privacy protection, possible disruptions, computer viruses or other damage to Internet servers or to users’ computers, and excessive governmental regulation.
Our success will depend, in large part, on third parties maintaining the Internet infrastructure to provide a reliable network backbone with the speed, data capacity, security and hardware necessary for reliable Internet access and services.
We depend in part on Internet search engines to attract potential new members to visit our website. If Internet search engines’ methodologies are modified or our search result page rankings decline for other reasons, our new member growth could decline, and our business and operating results could be harmed.
We derive a significant amount of traffic to our website from consumers who search for pet medical insurance through Internet search engines, such as Google, Bing and Yahoo!. A critical factor in attracting consumers searching for pet medical insurance on the Internet to our website is whether we are prominently displayed in response to an Internet search relating to pet insurance. Algorithmic search result listings are determined and displayed in accordance with a set of formulas or algorithms developed by the particular Internet search engine, which may change from time to time. If we are listed less prominently in, or removed altogether from, search result listings for any reason, the traffic to our websites would decline and we may not be able to replace this traffic, which in turn would harm our business, operating results and financial condition. If we decide to attempt to replace this traffic, wecredit carryforwards may be required to increase our saleslimited by previous and marketing expenditures, including by utilizing paid search advertising, which would also increase our pet acquisition costs and harm our business, operating results and financial condition.future ownership changes.
Changes in the economy may negatively impact our business, operating results and financial condition.
Our business may be affected by changes in the economic environment. Pet medical plans areMedical insurance for cats and dogs is a discretionary purchase, and members may reduce or eliminate their discretionary spending during an economic downturn, resulting in an increase in medical plan subscription terminations and a reduction in the number of new member enrollments. We may experience a material increase in medical plan subscription terminations or a material reduction in our member retention rate in the future, especially in the event of a prolonged recessionary period or a downturn in economic conditions. Conversely, consumers may have more income to pay veterinary costs out-of-pocket and less desire to purchase a pet medical planour subscription during a period of economic growth. In addition, media prices may increase during a period of economic growth, which could increase our sales and marketing expenses. As a result, our business, operating results and financial condition may be significantly affected by changes in the economic environment.
We may acquire other companies or technologies, which could divert our management’s attention, result in additional dilution to our stockholders and otherwise disruptare expanding our operations and harm our operating results.
We may decide to acquire businesses, products and technologies. Our ability to successfully make and integrate acquisitions is unproven. The pursuit of potential acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated. Further, even if we successfully acquire additional businesses or technologies, we may not be able to migrate the policyholders to our medical plan, integrate the acquired personnel, operations and technologies successfully, or effectively manage the combined business following the acquisition. We also may not achieve the anticipated benefits from the acquired business or technology. In addition, we may unknowingly inherit liabilities from future acquisitions that arise after the acquisition and are not adequately covered by indemnities. Acquisitions could also result in dilutive issuances of equity securities or the incurrence of debt, which could adversely affect our operating results. If an acquired business or technology fails to meet our expectations, our business, operating results and financial condition may suffer.
Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.
As of December 31, 2016, we had U.S. federal net operating loss carryforwards of approximately $79.0 million that will begin to expire in 2027. Under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, if a corporation undergoes an “ownership change,” the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes, such as research tax credits, to offset its post-change income and taxes may be limited. In general, an “ownership change” generally occurs if there is a cumulative change in our ownership by “5-percent stockholders” that exceeds 50 percentage points over a rolling three-year period. Similar rules may apply under state tax laws. Pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of the Company’s net operating loss carryforwards and credit carryforwards may be limited if the Company experiences an ownership change. As of the date of our Section 382 study, September 30, 2016, we believe the utilization of approximately$0.5 millionof net operating losses are subject to limitation as a result of prior ownership changes however subsequent ownership changes may have already and may further affect the limitation in future years.
We may explore opportunities to expand our operations globally,internationally, and we may therefore become subject to a number of risks associated with international expansion and operations.
As part of our growth plan, we have explored, and expect to continue to explore, opportunities to expand our operations globally.internationally. For instance, we recently entered the Australian market through a joint venture and we may enter other countries. We have no history of marketing, selling, administrating and supporting our medical plan tosubscription for consumers outside of the United States, Canada, and Puerto Rico. InternationalIn general, international sales and operations aremay be subject to a number of risks, including the following:
•regulatory rules and practices, foreign exchange controls, tariffs, tax laws and treaties that are different than those we operate under in the United States, Canada and Puerto Rico and that carry a greater risk of unexpected changes;currently;
•the costs and resources required to modify our technology and sell our medical plan in non-English speaking countries;
the costs and resources required to modify our medical plansubscription appropriately to suit the needs and expectations of residents and veterinarians in such foreign countries;
•our data analytics platform may have limited applicability in foreign countries, which may impact our ability to develop adequate underwriting criteria and accurately price subscriptions to our medical plan in such countries;
•increased expenses incurred in establishing and maintaining office space and equipment for our international operations;
•technological incompatibility;incompatibility between our patented proprietary software and software used by veterinarians;
fluctuations in exchange rates between the U.S. dollar and foreign currencies in markets where we do business;
difficulties in attracting and retaining personnel with experience in international operations;
•difficulties in modifying our business model or subscription in a manner suitable for any particular foreign country, including any modifications to our Territory Partner model to the extent we determine that our existing model is not suitable for use in foreign countries;
•our lack of experience in marketing to consumers and veterinarians and encouraging online marketing in foreign countries;
•our relative lack of industry connections in many foreign countries;
•difficulties in managing operations due to language barriers, distance and time zone differences, staffing, cultural differences and business infrastructure constraints, including difficulty in obtaining foreign and domestic visas;
application of foreign laws and regulations to us, including more stringent or materially different insurance, employment, consumer and data protection laws;
•the uncertainty of protection for intellectual property rights in some countries; and
greater risk of a failure of foreign employees to comply with applicable U.S. and foreign laws, including antitrust regulations, the U.S. Foreign Corrupt Practices Act and any trade regulations ensuring fair trade practices; and
•general economic and political conditions in these foreign markets.
These factors and other factors could harm our ability to gain future international revenue and, consequently, materially impact our business and operating results. The expansion of our existing international operations and entry into additional international markets will require significant management attention and financial resources, detracting from management attention and financial resources otherwise available to our existing business. Our failure to successfully manage our international operations and the associated risks effectively could limit the future growth of our business and could have an adverse effect on our operating results and financial condition.
A downgrade in the financial strength rating of our insurance company may have an adverse effect on our competitive position, the marketability of our medical plan, and/or on our liquidity, access to and cost of borrowing, operating results and financial condition.
Although we do not believe that the financial strength rating of APIC is material for customers or to understand our business beyond what is already publicly available, financial strength ratings can be important factors in establishing the competitive position of insurance companies and generally have an effect on an insurance company’s business. On an ongoing basis, rating agencies review the financial performance and condition of APIC and could downgrade or change the outlook on its ratings due to, for example, a change in its statutory capital, a change in the rating agency’s determination of the amount of risk-based capital required to maintain a particular rating or a reduced confidence in management or its business strategy, as well as a number of other considerations that may or may not be under our control. The insurance financial strength rating of APIC is subject to quarterly review, and APIC may not retain the current rating. A downgrade in this or any future ratings could have a material effect on our sales, our competitiveness, the marketability of our medical plan, our liquidity, access to and cost of borrowing, operating results and financial condition.
Our business is subject to the risks of earthquakes, floods, fires and other natural catastrophic events and to interruption by man-made problems such as computer viruses or terrorism.
Our systems and operations are vulnerable to damage or interruption from earthquakes, human error, intentional bad acts, hurricanes, floods, fires, power losses, telecommunications failures, hardware and system failures, terrorist attacks, acts of war, break-ins or similar events. For example, our corporate headquarters and facilities are located in Seattle, Washington near known earthquake fault zones and are vulnerable to significant damage from earthquakes. In addition, acts of terrorism could cause disruptions in our business or the economy as a whole. Our servers and systems may also be vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems, which could lead to interruptions, delays, loss of critical data or the unauthorized disclosure of confidential member data. We currently have limited disaster recovery capability, and our business interruption insurance may be insufficient to compensate us for losses that may occur. Such disruptions could negatively impact our ability to run our business, which could have an adverse effect on our operating results and financial condition.
Risks Related to Compliance with Laws and Regulations
We may not maintain the amount of risk-based capital required to avoid additional regulatory oversight, which may adversely affect our ability to operate our business.
Memberships in our U.S. medical plansubscription product are writtenunderwritten by APIC. APIC is an insurance company domiciled in the state of New York and licensed by the New York Department of Financial Services.Services (NY DFS). Regulators in the states in which we do business impose risk-based capital requirements on APIC that generally are approved by the National Association of Insurance Commissioners (NAIC) to ensure APIC maintains reasonably appropriate levels of surplus to protect our members against adverse developments in APIC’s financial circumstances, taking into account the risk characteristics of our assets, liabilities and certain other items. Generally, the NY DFSstate insurance regulators will compare, on an annual basis as of December 31 or more often as deemed necessary, an insurer’s total adjusted capital and surplus against what is referred to as an “Authorized Control Level” of risk-based capital that is calculated based on a formula designed to estimateassess an insurer’s capital adequacy. There generally are five outcomes possible from this comparison, depending on theIf an insurer’s level of risk-based capital as compared tofalls below a specific threshold, the applicable Authorized Control Level.
No Action Level: Insurer’s total adjusted capital is equal to or greater than 200% of the Authorized Control Level.
Company Action Level: Insurer’s total adjusted capital is less than 200% but greater than 150% of the Authorized Control Level. When at this level,regulator may take action, which can range from directing an insurer must prepare and submitto propose a financial plan to the NY DFS for review and approval. Generally, a risk-basedincrease its capital plan would identify the conditions that contributed to the Company Action Level and include the insurer’s proposed plans for increasing its risk-based capital in orderan acceptable level to satisfy the No Action Level. The failure to provide the NY DFS with a risk-based capital plan on a timely basis or the inability of the NY DFS and the insurer to mutually agree on an appropriate risk-based capital plan could trigger a Regulatory Action Level outcome, subject to the insurer’s right to a hearing on the issue.
Regulatory Action Level: Insurer’s total adjusted capital is less than 150% but greater than 100% of the Authorized Control Level. When at this level, an insurer generally must provide a risk-based capital plan to the NY DFS and be subject to examination or analysis by the NY DFS to the extent it deems necessary, including such corrective actions as the NY DFS may require.
Authorized Control Level: Insurer’s total adjusted capital is less than 100% but greater than 70% of the Authorized Control Level. At this level, the NY DFS generally could take remedial actions that it determines necessary to protect the insurer’s assets, including placing the insurer under regulatory control.
Mandatory Control Level: Insurer’s total adjusted capital is less than 70% of the Authorized Control Level. At this level, the NY DFS generally is required to take steps to place the insurer under regulatory control, even if the insurer is still solvent.
As of December 31, 2016, APIC was required to maintain at least $25.8 million ofApplicable regulations regarding risk-based capital to satisfymay change, and/or the No Action Level (the highest of the above levels). As of December 31, 2016, APIC maintained $30.5 million of risk-based capital. The NY DFS may increase theAPIC’s required levels of risk-based capital in the future, andfuture. Regardless, we anticipate that we will need to maintain greater amounts of risk-based capital if our pet enrollment continues to grow.
Additionally, ifa reduction in our risk-based capital falls below the Company Action Level, we may beresult in a breach of various contractual relationships, including, for example, with the unaffiliated general agents for which we write pet insurance policies, which may give such parties the ability to cancel their contracts with us and/or sue us for damages related to our risk-based capital levels, which could have a material adverse effect on our financial condition.
We may require additional capital to meet our risk-based capital requirements, pursue our business objectives and respond to business opportunities, challenges or unforeseen circumstances. If capital is not available to us at any time, our business, operating results and financial condition may be harmed.
We may require additional capital to meet our risk-based capital requirements, operate or expand our business or respond to unforeseen circumstances. Additional funds may not be available when we need them, on terms that are acceptable to us, or at all. If we raise additional funds through the issuance of equity or convertible securities, the percentage ownership of holders of our common stock could be significantly diluted and these newly issued securities may have rights, preferences or privileges senior to those of holders of our common stock. Further, volatility in the credit or equity markets may have an adverse effect on our ability to obtain debt or equity financing or the cost of such financing. Similarly, our access to funds may be impaired if regulatory authorities or rating agencies take negative actions against us. If a combination of these factors were to occur, our internal sources of liquidity may prove to be insufficient and, in such case, we may not be able to successfully obtain additional financing on favorable terms. If funds are unavailable to us on reasonable terms when we need them, we may be unable to meet our risk-based capital requirements, train and support our employees, support Territory Partners, maintain the competitiveness of our technology, pursue business opportunities, service our existing debt, pay claimsveterinary invoices or acquire new members, any of which could have an adverse effect on our business, operating results and financial condition.
IfOur business is heavily regulated, and if we fail to comply with the numerous applicable laws and regulations that are applicable to the sale of a pet medical plan, our business and operating results could be harmed.
The sale of a pet medical plan,insurance for cats and dogs, which is considered a type of property and casualty insurance in most jurisdictions, is heavily regulated by eachfederal, state, in the United States, in the District of Columbia, in Puerto Rico and by Canadian federal, provincial and territorial governments.governments in each jurisdiction in which we operate. In the United States, state insurance regulators are charged with protecting policyholders and have broad regulatory, supervisory and administrative powers over our business practices. Because we do business in all 50 states, the District of Columbia, all Canadian provinces and territories, and Puerto Rico, compliance with insurance-related laws, rules and regulations is difficult and imposes significant costs on our business. Each jurisdiction’s insurance department typically has the power, among other things, to:
•grant and revoke licenses to transact insurance business;
•conduct inquiries into the insurance-related activities and conduct of agents and agencies and others in the sales, marketing and promotional channels;
•require and regulate disclosure in connection with the sale and solicitation of insurance policies;
•authorize how, by which personnel and under what circumstances insurance premiums can be quoted and published and an insurance policy sold;
approve which entities can be paid commissions from carriers and the circumstances under which they•regulate how sales incentives may be paid;structured;
•regulate the content of insurance-related advertisements, including web pages, and other marketing practices;
•approve policy forms, require specific benefits and benefit levels and levels;
•regulate premium rates;
•impose fines and other penalties; and
•impose continuing education requirements.
While the U.S. federal government does not directly regulate the insurance industry, federal legislation and administrative policies can also affect us. Congress and various federal agencies periodically discuss proposals that would provide for federal oversight of insurance companies. We cannot predict whether any such laws will be enacted or the effect that such laws would have on our business. We also do business in all ten provinces and three territories of Canada. The provincial and territorial insurance regulators have the power to regulate the market conduct of insurers and insurance intermediaries, and the licensing and supervision of insurance agents, brokers, and adjusters,brokers, along with enforcement rights, including the right to assess administrative monetary penalties in certain provinces.
Insurance companies are also regulated at the federal level in Canada, and the Insurance Companies Act prohibits a foreign entity from insuring risks in Canada unless it is authorized by an Order made by the Superintendent of Financial Institutions (Canada) permitting it to do so.
Due to the complexity, periodic modification and differing interpretations of insurance laws and regulations, we have not always been, and we may not always be, in compliance with them. New insuranceA regulator’s interpretation of existing laws or regulations and guidelines also may not be compatible with the manner in which we market and sell subscriptions to our medical plan in all of our jurisdictions and member acquisition channels, including over the Internet.change without notice. Failure to comply with insurance laws, regulations and guidelines or other laws and regulations applicable to our business could result in significant liability, additional department of insurance licensing requirements, the revocation of licenses in a particular jurisdiction or our inability to sell subscriptions, to our medical plan, which could significantly increase our operating expenses, result in the loss of our revenue and otherwise harm our business, operating results and financial condition.
Moreover, because adverse regulatory actions in one jurisdiction must be reported to other jurisdictions, an adverse regulatory action in one jurisdiction could result in penalties and adversely affect our license status or reputation in other jurisdictions, including due to the current requirement that adverse regulatory actions in one jurisdiction be reported to other jurisdictions. Even if the allegations in any regulatory or other action against us ultimately are determined to be unfounded, we could incur significant time and expense defending against the allegations, and any related negative publicity could harm consumer and third-party confidence in us, which could significantly damage our brand.
In addition, we have received, and may in the future receive, inquiries from regulators regarding our marketing and business practices. These inquires may include investigations regarding a number of our business practices, including the manner in which we market and sell subscriptions, to our medical plan and the manner in which we write policies for any unaffiliated general agent.agent, and whether any amounts we pay to hospitals or hospital groups is appropriate. Any modification of our marketing or business practices in response to regulatory inquiries could harm our business, operating results or financial condition.condition and lead to reputational harm.
A regulatory environmentStates may adopt new laws that limits rate increases may adversely affect our operating results and financial condition.
The NAIC may draft model laws that focus on medical insurance for pets. States may enact new laws to adopt what the NAIC drafts, or a state may enact its own new laws or regulations that could affect our industry. Many states including New York, have adopted laws or are consideringconsidered and may continue to consider proposed legislation that among other things, limit thecould significantly affect our operations, including, for example, our ability of insurance companies to effect rate increases, or to cancel reduce or not renew insurance coverage with respect toissue existing policies, or how to market our product. Implementing changes in order to comply with new laws or regulations could also be time-consuming and many state regulators have the powercostly.
We may not receive approval for changes to reduce,an existing product, for a proposed new product or to disallow increasesfor pricing changes, or we may not receive such approvals in premium rates. a timely manner.
Most states including New York, require licensure and regulatory approval prior to marketing new insurance products or changing premiums for existing products. OurFrom time to time, we seek to make updates to our existing subscription product. We may also introduce new products that make changes that are more extensive to the product approved in a state. With respect to pricing, our practice has been to regularly reevaluate the price of our medical plan subscriptions, with any pricing changes implemented at least annually, subject to the review and approval of the state regulators, who may reduce or disallow our pricing changes. Such review has often in the past resulted, and may in the future result, in delayed implementation of pricing changes and prevent us from making changes we believe are necessary to achieve our targeted claims payout ratio, which could adversely affect our operating results and financial condition. In addition, weA delayed approval may be prevented by regulators from limiting significant pricing changes, requiringrequire us to raise rates more quickly than we otherwise may desire. This could damage our reputation with our members and reduce our retention rates, which could significantly damage our brand, result in the loss of expected revenue and otherwise harm our business, operating results and financial condition.
In addition to regulating rates, certainWe may be affected by mandatory participation in plans that could result in contributions from insurance subsidiaries we own.
Certain states have enacted laws that require a property-casualty insurer, which includes a pet insurance company, conducting business in that state to participate in assigned risk plans, reinsurance facilities, joint underwriting associations (JUAs), Fair Access to Insurance Requirements (FAIR) plans and wind pools. In these markets, if the state reinsurance facilities, wind pools, FAIR plans or JUAs recognize a financial deficit, they may in turn have the ability to assess participating insurers, adversely affecting our operating results and financial condition if we are a part of such state reinsurance facilities, wind pools, FAIR plans or JUAs. Additionally, certain states require insurers to participate in guaranty funds for impaired or insolvent insurance companies. These funds periodically assess losses against all insurance companies doing business in the state. Our operating results and financial condition could be adversely affected by any of these factors.
Regulations that require individuals or entities that sell medical insurance for cats and dogs or adjustprocess claims to be licensed may be interpreted to apply to our business more broadly than we expect them to, which could require us to modify our business practices.practices, create liabilities, damage our reputation, and harm our business.
Insurance regulatorsregulations generally require that each individual who transacts petsells, solicits or negotiates insurance business on our behalf must maintain a valid license in onethe jurisdiction in which the activity occurs. Regulations also generally prohibit paying an insurance commission to an unlicensed person or more jurisdictions. Subject to exceptions, certain statesentity. Regulations may also require thatcertain individuals who adjust insuranceprocess claims obtain an insurance adjuster license.to be licensed. These requirements are subject to a variety of interpretations between jurisdictions. We may not interpret and apply the requirements in the same manner as all applicable regulators, and, even if we have, the requirements or regulatory interpretations of those requirements may change. Regulators have in the past and/or may in the future determine that certain of our personnel or referral sourcesthird parties were performing licensable activities without the required license.license, including for example a veterinary hospital employee. If such persons were not in fact licensed in any such jurisdiction, we could become subject to conviction for an offense or the imposition of an administrative penalty, and liable for significant penalties. Regulators may also deem payments we make to an unlicensed entity or person to be improper. We would also likely be required to modify our business practices and/or sales and marketing programs, or license the affected individuals, which may be impractical or costly and time-consuming to implement. Any modification of our business or marketing practices in response to regulatory licensing requirements could harm our business, operating results or financial condition.
Most insurance legislation requires entities that solicit the sale of pet insurance to be validly licensed in the applicable jurisdiction. If an insurance regulator were to determine that any entity soliciting the sale of a medical plan on our behalf did not hold the required license, we may have to modify our business practices or marketing efforts, or license the affected entities, which may be costly and time-consuming to implement.
We are subject to numerous laws and regulations, and compliance with one law or regulation may result in non-compliance with another.
We are subject to numerous laws and regulations that are administered and enforced by a number of different governmental authorities, each of which exercises a degree of interpretive latitude, including, in the United States, state insurance regulators, state securities administrators, state attorneys general and federal agencies including the SEC, Internal Revenue Service and the U.S. Department of Justice. Consequently, we are subject to the risk that compliance with any particular regulator’s or enforcement authority’s interpretation of a legal issue may not result in compliance with another’s interpretation of the same issue, particularly when compliance is judged in hindsight. In addition, there is risk that laws and regulations or any particular regulator’s or enforcement authority’s interpretation of a legal issue may change over time to our detriment, or that changes in the overall legal environment may, even absent any particular regulator’s or enforcement authority’s interpretation of a legal issue changing, cause us to change our views regarding the actions we need to take from a legal risk management perspective, thus necessitating changes to our practices that may, in some cases, increase our costs and limit our ability to grow or to improve the profitability of our business. Further, in some cases, these laws and regulations are designed to protect or benefit the interests of a specific constituency rather than a range of constituencies. For example, state insurance laws and regulations generally are intended to protect or benefit purchasers or users of insurance products, not holders of securities, which generally is the jurisdiction of the SEC. In many respects, these laws and regulations limit our ability to grow or to improve the profitability of our business.
Regulation of the sale of medical insurance for cats and dogs is subject to change, and future regulations could harm our business and operating results.
The laws and regulations governing the offer, sale and purchase of medical insurance for cats and dogs are subject to change, and future changes may be adverse to our business. For example, if a jurisdiction were to increase our risk-based capital requirements or alter the requirements for obtaining or maintaining an agent’s license in connection with the enrollment of a member in our medical plan, it could have a material adverse effect on our operations. Some states in the United States have adopted, and others are expected to adopt, new laws and regulations related to the insurance industry. It is difficult to predict how these or any other new laws and regulations will impact our business, but, in some cases, changes in insurance laws, regulations and guidelines may be incompatible with various aspects of our business and require that we make significant modifications to our existing technology or practices, which may be costly and time-consuming to implement and could also harm our business, operating results and financial condition.
Failure to comply with federal, state and provincial laws and regulations relating to privacy and security of personal information, and civil liabilities relating to breaches of privacy and security of personal information, could create liabilities for us, damage our reputation and harm our business.
A variety of U.S. and Canadian federal, state and provincial laws and regulations govern the collection, use, retention, sharing and security of personal information. We collect and utilize demographic and other information from and about our members when they visit our website, call our contact center and apply for enrollment in our medical plan. Further, we use tracking technologies, including “cookies,” to help us manage and track our members’ interactions and deliver relevant advice and advertising. Claims or allegations that we have violated applicable laws or regulations related to privacy and data security could in the future result in negative publicity and a loss of confidence in us by our members and our participating service providers, and may subject us to fines by credit card companies and the loss of our ability to accept credit and debit card payments. In addition, we have posted privacy policies and practices concerning the collection, use and disclosure of member data on our website. Several Internet companies have incurred penalties for failing to abide by the representations made in their privacy policies and practices. In addition, our use and retention of personal information could lead to civil liability exposure in the event of any disclosure of such information due to hacking, viruses, inadvertent action or other use or disclosure. Several companies have been subject to civil actions, including class actions, relating to this exposure.
We have incurred, and will continue to incur, expenses to comply with privacy and security standards and protocols for personal information imposed by law, regulation, self-regulatory bodies, industry standards and contractual obligations. Such laws, standards and regulations, however, are evolving and subject to potentially differing interpretations, and federal, state and provincial legislative and regulatory bodies may expand current or enact new laws or regulations regarding privacy matters. We are unable to predict what additional legislation, standards or regulation in the area of privacy and security of personal information could be enacted or its effect on our operations and business.
Government regulationLaw and regulations of the Internet, email and emailtexting could adversely affect our business.
TheMany laws governing general commerce on the Internet remain unsettled and it may take years to fully determine whether and how existing laws such as those governing insurance, intellectual property, privacy and taxation apply to the Internet. In addition, the growth and development of the market for electronic commerce and Internet-related pet medical planinsurance advertisements and transactions may prompt calls for more stringent consumer protection laws that may impose additional burdens on companies conducting business and selling subscriptions to a pet medical plan over the Internet. Any new laws or regulations or new interpretations of existing laws or regulations relating to the Internet could harm our business and we could be forced to incur substantial costs in order to comply with them, which would harm our business, operating results and financial condition.
Additionally, we use phone solicitation, email and texting to market our services to potential members andand/or as a means of communicating with our existing members. The laws and regulations governing the use of phone solicitation, email for commercial purposesand texting continue to evolve, and the growth and development of the market for commerce over the Internet may lead to the adoption of additional legislation. Failure to comply with existing or new laws regarding phone solicitation, text or electronic communications with customersmembers could lead to significant damages. We have incurred, and will continue to incur, expenses in our efforts to comply with electronic messaging laws. If new laws or regulations are adopted, or existing laws and regulations are interpreted, to impose additional restrictions on our ability to send email to our members or potential members, we may not be able to communicate with them in a cost-effective manner. In addition to legal restrictions on the use of email for commercial purposes, Internet and email service providers and others attempt to block the transmission of unsolicited email, commonly known as “spam.” Many service providers have relationships with organizations whose purpose it is to detect and notify the Internet and email service providers of entities that the organization believes isare sending unsolicited email. If an Internet or email service provider identifies messaging and email from us as “spam” as a result of reports from these organizations or otherwise, we could be placed on a restricted list that will block our emails to members or potential members. If we are restricted or unable to communicate by phone, text or email with our members and potential members as a result of legislation, blockage or otherwise, our business, operating results and financial condition would be harmed.
Applicable insurance laws regarding the change in control of our company may impede potential acquisitions that our stockholders might consider to be desirable.
We are subject to statutes and regulations of the state of New York that generally require that any person or entity desiring to acquire direct or indirect control of APIC obtain prior regulatory approval. These laws may discourage potential acquisition proposals and may delay, deter or prevent a change in control of our company, including through transactions, and in particular unsolicited transactions, that some of our stockholders might consider to be desirable. Similar laws or regulations may also apply in other states in which we may operate.
Our segregated account in Bermuda, WICL segregated account AX, could be adversely impacted by regulatory compliance of aan unaffiliated third party.
Wyndham Insurance Company (SAC) Limited (WICL) is a class 3 insurer regulated by the Bermuda Monetary Authority (BMA). WICL'sWICL’s ability to continue operations and pay dividends could impact the ability of our segregated account to do the same. WICL'sWICL’s failure to meet regulatory requirements set forth by the BMA could result in our inability to transact business with WICL segregated account AX. Further, WICL could be limited from allowing dividends to be paid out of segregated account AX in the event of adverse regulatory actions.
We will continueOur accounting is becoming more complex, and relies upon estimates or judgments relating to incur significantly increased costsour critical accounting policies. If our accounting is erroneous or based on assumptions that change or prove to be incorrect, our operating results could fall below the expectations of securities analysts and devote substantialinvestors, resulting in a decline in our stock price.
The preparation of financial statements in conformity with GAAP requires management time as a result of operating as a public company.
As a public company, we incur significant legal, accountingto make estimates and other expensesassumptions that we did not incur as a private company. For example, we are subject toaffect the reporting requirements ofamounts reported in the Exchange Act,consolidated financial statements and are requiredaccompanying notes, and also to comply with the applicablemany complex requirements of the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act and the JOBS Act, as well as rules and regulations subsequently implemented by the SEC and the stock exchange on which our common stock is listed, including the establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Compliance with these requirements has and may continue to increase our legal and financial compliance costs and will make some activities more time consuming and costly. In addition, from time to time, our management and other personnel need to divert attention from operational and other business matters tostandards. We devote substantial timeresources to these public company requirements. In particular, we have and will continue to incur significant expenses and devote substantial management effort toward ensuring compliance with theaccounting requirements of Section 404 of the Sarbanes-Oxley Act, which will increase when we are no longer an emerging growth company, as defined by the JOBS Act. We cannot predict or estimate the amount of additional costs we may incur as a result of being a public company or the timing of such costs.
We are an emerging growth company and we cannotbase our estimates on our best judgment, historical experience, information derived from third parties, and on various other assumptions that we believe to be certain ifreasonable under the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.
We are an emerging growth company. Undercircumstances, the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselvesresults of this exemption from new or revised accounting standardswhich form the basis for making judgments about the carrying values of assets, liabilities, equity, revenue and therefore, we will be subject to the same new or revised accounting standards as other public companiesexpenses that are not emerging growth companies.
Forreadily apparent from other sources. However, various factors are causing our accounting to become complex, such as long asour recent building acquisition, our investments in strategic opportunities and our test expansion into foreign markets. Ongoing evolution of our business may compound these complexities. Our operating results may be adversely affected if we continuemake accounting errors or our judgments prove to be an emerging growth company, we intend to take advantage of certain exemptionswrong, assumptions change or actual circumstances differ from various reporting requirements that are applicable to other public companies including, but not limited to, reduced disclosure obligations regarding executive compensationthose in our periodic reportsassumptions, which could cause our operating results to fall below the expectations of securities analysts and proxy statements, and exemptions from the requirements of holdinginvestors or guidance we may have provided, resulting in a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock anddecline in our stock price may be more volatile.
We generally will remain an emerging growth company until the earliest of (i) the end of the fiscal yearand potential legal claims. Significant judgments, assumptions and estimates used in which the market value ofpreparing our common stock that is held by non-affiliates exceeds $700 million as of June 30, (ii) the end of the fiscal year in which we have total annual grossconsolidated financial statements include those related to revenue of $1 billion or more during such fiscal year, (iii) the date on which we issue more than $1 billion in non-convertible debt in a three-year period or (iv) December 31, 2019, which is the end of the year in which the fifth anniversary of our IPO would occur.recognition, stock-based compensation, business combinations, and income taxes.
Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States.
Generally accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board, the SEC and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results, could affect the reporting of transactions completed before the announcement of a change and could affect our compliance with financial debt covenants.
Risks Related to Ownership of Our Common Stock
Our actual operating results may differ significantly from our guidance.
From time to time we have released, and may continue to release, guidance in our quarterly earnings conference call, quarterly earnings releases, or otherwise, regarding our future performance that represents our management’s estimates as of the date of release. This guidance, which includes forward-looking statements, has been and will be based on projections prepared by our management. These projections are not prepared with a view toward compliance with published guidelines of the American Institute of Certified Public Accountants, and neither our independent registered public accountantsaccounting firm nor any other independent expert or outside party compiles or examines the projections. Accordingly, no such person expresses any opinion or any other form of assurance with respect to the projections. In addition, we have recently provided information regarding how we think about the drivers of and our method of calculating our intrinsic value, including related statements regarding discounted cash flows and underlying assumptions (such as pet enrollment, revenue per pet, lifetime values of a pet, pet acquisition costs, and other costs and expenses).
ProjectionsThese statements are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significant business, economic and competitive uncertaintiesrisks and contingencies,uncertainties, many of which are beyond our control, including those described in these “Risk Factors” and are based upon specific assumptions with respect to future business decisions, some of which will change.elsewhere in this report. We intend to state possible outcomes as high and low ranges which are intended to provide a sensitivity analysis as variables are changed but are not intended to imply that actual results could not fall outside of the suggested ranges.
The principal reason that we release guidance and other information regarding our view of the drivers and calculation method of our intrinsic value is to provide a basis for our management to discuss our business and outlook with analysts and investors. We do not accept any responsibility for any projections or reports published by any such third parties.
Guidance is necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the guidance furnished by usthese statements will not materialize or will vary significantly from actual results. Accordingly, our guidance isthese statements are only an estimateestimates of what management believes is realizablereasonable as of the date of release. Actual results may vary from our guidance and the variations may be material. In light of the foregoing, investors are urged not to rely upon our guidance or other information regarding our view of the drivers and calculation method of our intrinsic value in making an investment decision regarding our common stock. In addition, we do not accept any responsibility for any projections or reports published by any such third parties, and we urge you not to place undue reliance on those statements.
Any failure to successfully implement our operating strategy or the occurrence of any of the events or circumstances set forth in this report could result in the actual operating results being different from our guidance, and the differences may be adverse and material.
If securities or industry analysts do not publish research, or publish inaccurate or unfavorable research, about our business, our stock price and trading volume could decline.
The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the securities or industry analysts who publish research about us or our business downgrade our stock or publish inaccurate or unfavorable evaluations of our company or our stock, the price of our stock could decline. If one or more of these analysts cease coverage of our company, our stock may lose visibility in the market, which in turn could cause our stock price to decline.
The market price of our common stock has been and is likely to continue to be volatile, and you may be unable to sell your shares at or above the price at which you purchased them.
The market price of our common stock has been and is likely to continue to fluctuate widely. Factors affecting the market price of our common stock include:
•variations in our operating results, earnings per share, cash flows from operating activities, and key financial and operationaloperating metrics, and how those results compare to analyst expectations;
•forward-looking guidance that we provide to the public and industry and financial analysts related to future revenue and profitability, and any change in that guidance or our failure to achieve the results reflected in that guidance;
•the net increases in the number of members, either independently or as compared with published expectations of industry, financial or other analysts that cover our company;
changes in the estimates of our operating results or changes in recommendations by securities analysts that elect to follow our common stock;
•announcements of changes to our medical plan,subscription, strategic alliances, acquisitions or significant agreements by us or by our competitors;
announcements by us or by our competitors of mergers or other strategic acquisitions, or rumors of such transactions involving us or our competitors;
•recruitment or departure of key personnel;
•the economy as a whole and market conditions in our industry;
•trading activity by a limited number of stockholders who together beneficially own a majority of our outstanding common stock;
•the number of shares of our stock trading on a regular basis; and
•any other factors discussed in these risk factors.
In addition, if the market for stock in our industry or the stock market in general experiences uneven investor confidence, the market price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The market price of our common stock might also decline in reaction to events that affect other companies within, or outside, our industry even if these events do not directly affect us. Some companies that have experienced volatility in the trading price of their stock have been the subject of securities class action litigation. If we are the subject of such litigation, it could result in substantial costs and a diversion of our management’s attention and resources.
We do not intend to pay dividends on our common stock and, therefore, any returns will be limited to the value of our stock.
We have never declared or paid any cash dividends on our common stock. WeOther than potential repurchases of our common stock, we currently intend to retain all available funds and any future earnings for the development, operation and expansion of our business and do not anticipate declaring or paying any cash dividends for the foreseeable future. In addition, our ability to pay cash dividends on our common stock is limited by the terms of our credit agreement, APIC’s ability to pay dividends is limited by New York state insurance laws, and WICL Segregated Account AX'sAX’s ability to pay dividends is limited by our agreements with WICL as well as WICL'sWICL’s regulatory requirements. Any return to stockholders will therefore be limited to the increase, if any, of our stock price.
Our directors and principal stockholders own a significant percentage of our stock and will be able to exert significant control over matters subject to stockholder approval.
Our directors, five percent or greater stockholders and their respective affiliates beneficially hold a significant amount of our outstanding voting stock. Therefore, these stockholders have the ability to influence us through this ownership position. These stockholders may be able to determine all matters requiring stockholder approval. For example, these stockholders may be able to control elections of directors, amendments of our organizational documents, or approval of any merger, sale of assets, or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you or other stockholders may feel are in your or their best interest as one of our stockholders.
Provisions in our restated certificate of incorporation, restated bylaws and Delaware law might discourage, delay or prevent a change in control of our company or changes in our management and, therefore, depress the market price of our common stock.
Our restated certificate of incorporation and restated bylaws contain provisions that could depress the market price of our common stock by acting to discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions, among other things:
•establish a classified board of directors so that not all members of our board are elected at one time;
•permit only the board of directors to establish the number of directors and fill vacancies on the board;
•provide that directors may only be removed “for cause” and only with the approval of two-thirds of our stockholders;
•require super-majority voting to amend some provisions in our restated certificate of incorporation and restated bylaws;
•authorize the issuance of “blank check” preferred stock that our board could use to implement a stockholder rights plan (also known as a “poison pill”);
•eliminate the ability of our stockholders to call special meetings of stockholders;
•prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
•prohibit cumulative voting; and
•establish advance notice requirements for nominations for election to our board or for proposing matters that can be acted upon by stockholders at annual stockholder meetings.
In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control of our company. Section 203 imposes certain restrictions on mergers, business combinations and other transactions between us and holders of 15% or more of our common stock.
Item 2. Unregistered SaleSales of Equity Securities and Use of Proceeds
None.Issuer Purchases of Equity Securities
SIGNATURES
PursuantIn November 2019, we announced a share repurchase program, pursuant to which we may repurchase up to $15.0 million in outstanding shares over the requirements12 months following the approval. Under the program, we may repurchase shares through open market purchases, privately-negotiated transactions, block purchases or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange ActAct. While our board of 1934,directors has approved the Registrant has duly causedprogram, any repurchase will be subject to quarterly assessments based on parameters we set. These include uses of capital in a given quarter, the stock price relative to our estimated intrinsic value, and general market conditions.
We did not repurchase any shares under this Quarterly Report on Form 10-Q to be signed on its behalf byprogram during the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, on this 2nd day of November 2017.quarter ended September 30, 2020.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.
Item 6. Exhibits
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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| Exhibit | | | | Incorporated by Reference | | Filed/Furnished |
| Number | | Exhibit Description | | Form | | File No. | | Exhibit | | Exhibit Filing Date | | Herewith |
| | | | | | | | | | | | |
| | | | 10-Q | | 001-36537 | | 3.1 | | 8/28/2014 | | |
| | | | | | | | | | | | |
| | | | 8-K | | 001-36537 | | 3.1 | | 6/3/2016 | | |
| | | | | | | | | | | | |
| | | | 10-Q | | 001-36537 | | 3.2 | | 8/28/2014 | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | X |
| | | | | | | | | | | | |
| | | | | | | | | | | | X |
| | | | | | | | | | | | |
| | | | | | | | | | | | X |
| | | | | | | | | | | | |
| | | | | | | | | | | | X |
| | | | | | | | | | | | |
| 101.INS | | XBRL Instance Document - the instance does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document | | | | | | | | | | X |
| | | | | | | | | | | | |
| 101.SCH | | Inline XBRL Taxonomy Extension Schema Document. | | | | | | | | | | X |
| | | | | | | | | | | | |
| 101.CAL | | Inline XBRL Taxonomy Extension Calculation Linkbase Document. | | | | | | | | | | X |
| | | | | | | | | | | | |
| 101.DEF | | Inline XBRL Taxonomy Extension Definition Linkbase Document. | | | | | | | | | | X |
| | | | | | | | | | | | |
| 101.LAB | | Inline XBRL Taxonomy Extension Labels Linkbase Document. | | | | | | | | | | X |
| | | | | | | | | | | | |
| 101.PRE | | Inline XBRL Taxonomy Extension Presentation Linkbase Document. | | | | | | | | | | X |
| | | | | | | | | | | | |
| 104 | | Cover Page Interactive Data File (formatted in Inline XBRL and contained in Exhibit 101) | | | | | | | | | | X |
|
| | |
| | |
| | TRUPANION, INC. |
| |
Date: November 2, 2017 | | /s/ Darryl Rawlings |
| | Darryl Rawlings
Chief Executive Officer and President
(Principal Executive Officer)
|
| |
Date: November 2, 2017 | | /s/ Tricia Plouf |
| | Tricia Plouf
Chief Financial Officer
(Principal Financial and Accounting Officer)
|
EXHIBIT INDEX
|
| | | | |
| * | | | | |
Exhibit | | | | Filed/Furnished |
Number | | Exhibit Description | | Herewith |
| | | | |
10.1 | | | | X |
| | | | |
10.2 | | | | X |
| | | | |
31.1 | | | | X |
| | | | |
31.2 | | | | X |
| | | | |
32.1* | | | | X |
| | | | |
32.2* | | | | X |
| | | | |
101.INS | | XBRL Instance Document. | | X |
| | | | |
101.SCH | | XBRL Taxonomy Extension Schema Document. | | X |
| | | | |
101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document. | | X |
| | | | |
101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document. | | X |
| | | | |
101.LAB | | XBRL Taxonomy Extension Labels Linkbase Document. | | X |
| | | | |
101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document. | | X |
|
| |
* | This certification is deemed not filed for purpose of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.
| | | | | | | | |
| | |
| | TRUPANION, INC. |
| |
| Date: October 30, 2020 | | /s/ Darryl Rawlings |
| | Darryl Rawlings Chief Executive Officer and President (Principal Executive Officer) |
| |
| Date: October 30, 2020 | | /s/ Tricia Plouf |
| | Tricia Plouf Chief Financial Officer (Principal Financial and Accounting Officer) |