Trupanion, Inc. (TRUP) Q1 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the Trupanion Inc. First Quarter 2016 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note that this event is being recorded. I now would like to turn the conference over to Whitney Steininger [ph] of Investor Relations. Please go ahead, ma'am.

Good afternoon, and welcome to the Trupanion first quarter 2016 earnings results conference call. I'm joined today by Darryl Rawlings, Chief Executive Officer and Mike Banks, Chief Financial Officer. Each will be available for question-and-answers following today's prepared remarks. Before we begin, I would like to remind everyone that during today's conference call, we will make certain forward-looking statements regarding the future operations, opportunities, and financial performance of Trupanion within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements involve a high degree of known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed. A detailed discussion of these and other risks and uncertainties are included in our earnings release which can be found on our Investor Relations website as well as the company's most recent reports on Forms 10-Q and 8-K filed with the Securities and Exchange Commission. Today's presentation contains reference to non-GAAP financial measures that management uses to evaluate the company's performance, including, without limitation, variable expenses, fixed expenses, adjusted operating income, acquisition costs, adjusted EBITDA, and free cash flow. When we use the term adjusted operating income or margin, it is intended to refer to our non-GAAP operating income or margin before new pet acquisitions. Unless otherwise noted, margins and expenses will be presented on a non-GAAP basis, which excludes share-based compensation expense and depreciation expense. These non-GAAP measures are in addition to and not a substitute for measures of financial performance prepared in accordance with the U.S. GAAP. Investors are encouraged to review the reconciliations of these non-GAAP financial measures to the most directly comparable GAAP results, which can be found in today's press release or on Trupanion's Investors Relations website under the quarterly earnings tab. Lastly, I would like to remind everyone that today's call is also available via webcast on Trupanion's Investor Relations website. A replay will also be available on the site. With that, I would like to turn the call over to Darryl, Trupanion's Chief Executive Officer.

Thank you, Whitney and good afternoon, everyone. We appreciate your continued support and interest in Trupanion. On April 21, we published our 2015 annual report, which includes my second annual shareholder letter. I'll reference a few of the highlights today, but I would encourage you all to give it a comprehensive read as it provides some additional insights on how we operate and think about our business. Reflecting on our performance as a public company to date, I am pleased to report that we continued to deliver results in line with the plan that we outlined at the time of our IPO. Focusing on the first quarter 2016 by the numbers, Q1 marked our 34th consecutive quarter of revenue growth that exceeded 25%. Our revenue growth has been highly predictable and sustainable. We ended the first quarter with over 307,000 total enrolled pets. Enrolled pets for our direct-to-consumer monthly subscription business exceeded 287,000 or approximately 93% of our enrolled pet base. We continue to realize increasing scale in our adjusted operating income, which describes our operating profit from our existing members, before any cost to acquire new pets. As I highlighted in my shareholder letter, we ended 2015 with more territory partners in the field calling on the largest number of active hospitals in our history. Our member retention remains at near record highs, a metric we will continue to support by focusing on our value proposition and customer experience, including the increased availability of direct veterinary payment via Trupanion Express. I'll now address each of these items in greater detail. Starting with our financial performance, total revenue for the quarter was $42.7 million, an increase of 31% on a constant currency basis. Significantly, I believe the quality of our revenue growth has improved. During the quarter, we began to place an increasing focus on optimizing spend on our highest lifetime value categories while strategically reducing spend on our lower lifetime value categories. Pet acquisition costs declined and as a result, our LVP to PAC ratio was 4.9 to 1 in the quarter. This is in line with our long-term goal of 5 to 1. At the same time, we continue to grow our gross profit and realize increasing leverage in our fixed expenses, which drove a strong improvement in adjusted operating income. Adjusted operating income was 6.3% of revenue in the first quarter compared with 0.7% of revenue in the prior year period. Recall, that a reconciliation of the adjusted operating income is available on our IR website. Scaling our adjusted operating margin remains one of our top strategic priorities, and our strong progress keeps us on track to achieve our stated goal of cash flow breakeven by the second quarter or third quarter of this year. Our net loss for the period, after acquisition spend, was $2.6 million which compares to a net loss of $4.9 million in the prior year period. As we continue to expand our margin, we must also continue to grow our pet base at an appropriate level. We continue to target an LVP to PAC ratio of 5 to 1. As highlighted, our LVP to PAC ratio was a big focus for us in Q1 and we slowed spending in certain categories, where spend was not optimized. Categories with a higher lifetime value allow for a higher acquisition spend, while categories with a lower lifetime value should adhere to the same discipline. We have become increasingly granular and disciplined in our approach in recent months. Our national sales team of Territory Partners is the driving force, behind our pet acquisition efforts, within the veterinary channel and I'm very pleased with the continued improvements of our Territory Partner program. We ended the year with 84 Territory Partners, up from 70 Territory Partners in the prior year. In 2015, our Territory Partners made over 86,000 face-to-face visits with veterinarians and their staff in over 19,500 veterinary hospitals throughout North America. Expansion of our Territory Partners sales force remains a strategic priority for us to drive penetration of medical insurance for North American pets to surpass the approximate 1% it is today. As important as growing our sales force, investing in our existing Territory Partners is even more important. We’ve directed significant resources to improving the training that we provide our Territory Partners. Tru University is now in its third year and we're continually improving this extensive training program to help our Territory Partners. We're also spending more time in the field with our Territory Partners through management field visit and ride alongs, which is mutually beneficial. Our efforts are already paying off. The number of hospitals actively recommending us increased 26% in 2015 and now represent 7,660 of the 28,000 veterinary hospitals in the United States and Canada as of the end of 2015. This growth is even more significant when you consider the vast majority of our territory partners have been operating in markets where Trupanion has been building relationships for fewer than five years. In our more established markets, approximately 50% of hospitals are active and these hospitals deliver faster rates of enrollments than hospitals in less established markets. With the quality of our territory partners today, I am confident that the relationships they are working to build will pay dividends in the future. Our numbers also suggest that our value proposition and efforts to deliver a better customer experience are paying off. Our retention rate for the quarter was 98.65%, near our all-time highs. In our annual shareholder letter we provided retention by cohort year, which also indicates that our members are becoming increasingly loyal over time. This bodes well for our business. Our loyal members are more likely to enroll additional or future pets and provide important word-of-mouth referrals. In closing, I am pleased that we continued to deliver against our plans and we're looking forward to continued progress throughout the remainder of 2016. We have a highly predictable business model and an increasingly precise feel for the levers that drive our financial performance. We're feeling good about the balance we are striking between growth and our return on investment spend. I would now like to turn the call over to Mike.

Thanks, Darryl and good afternoon, everyone. We are pleased with Trupanion's strong financial performance in the first quarter of 2016. Total revenue was $42.7 million, a year-over-year increase of 31% on a constant currency basis. After foreign exchange conversion, total revenue increased 28% over the prior year period. Subscription revenues were $39.1 million and comprised 92% of our total revenues, and year-over-year growth was 30% driven by 26% growth in subscription pets and by continued strength in our average monthly retention rate, which was 98.65% for the first quarter. Monthly adjusted revenue per pet increased 4% year-over-year. In local currency, monthly adjusted revenue per pet increased by 7% from the prior year for our U.S. members and by 6% for our Canadian members. Other business revenues, which generally are comprised of our revenues that have a B2B component, totaled $3.6 million, up 9% from the first quarter of 2015. Total gross profit in the quarter was $7.3 million, a 31% improvement over the prior year period. Our subscription gross margin was 18%, in line with our long-term annual target of 18% to 21%. Turning to our cost structure, driving scale in our fixed expenses continues to be a key financial goal. In the first quarter, our fixed expenses as a percentage of revenue decreased once again and represented 11% of total revenues, down from 16% in the prior year period. This led to a strong improvement in our adjusted operating income. Adjusted operating income totaled $2.7 million in the first quarter or 6% of revenues compared to $226,000 or 1% of revenues in the prior year period. Let me turn now to our acquisition costs. In the first quarter, Trupanion spent an average of $123 to acquire a pet, with an average lifetime value of $603. For the quarter, this was a 4.9 to 1 ratio, up significantly from 4.2 to 1 in the prior year and back in line with our 5 to 1 targeted LVP to PAC ratio. Our free cash flow for the first quarter was negative $2 million, an improvement from negative $6.5 million in the prior year period. We generated a net loss of $2.6 million and adjusted EBITDA was a loss of $1.1 million. Turning to our balance sheet, we ended the quarter with $43.1 million in cash, cash equivalents, and short-term investments. Lastly, we ended the first quarter with 28.6 million in common shares outstanding and 32.2 million shares outstanding on a fully diluted basis. Turning to our outlook for the second quarter and full year; for the second quarter, we are initiating guidance as follows: total revenue is expected to be in the range of $44.5 million to $45.5 million, and adjusted EBITDA for the second quarter is expected to be a loss of between $500,000 to a loss of $1.5 million. Based on our performance in Q1 and favorable FX rates, we are increasing our revenue and adjusted EBITDA guidance for the full year. We’re now expecting total revenue in the range of $184 million to $187 million. Adjusted EBITDA is expected to be in the range of a loss of $1 million to a loss of $4 million. As a reminder, our revenue projections are subject to conversion rate movements between the U.S. and Canadian currencies. For the second quarter and full year 2016 guidance, we used a 77% conversion rate in our projections which was the approximate rate at the end of March 2016. Before I turn the call back over to Darryl, I want to announce my plans to retire as Trupanion's CFO. While today will mark my final earnings call as Trupanion's CFO, I look forward to working with the entire finance organization over the next several months to ensure a smooth transition. It's truly been an honor to be part of this great team and after four incredible years, I'm looking forward to taking some time for myself and my family. My primary objective when I became CFO was to take the company public. As one of my first tasks, I hired Tricia Plouf, our VP-Controller. She built our finance team, spearheaded our capital markets’ reporting and compliance, led our budgeting and planning efforts and has established herself as a leader in our finance organization. She will now take over my role as CFO, and I am confident that Tricia's deep financial acumen and intimate understanding of Trupanion's strategy and vision will make her an excellent leader to our organization. With that, I would like to thank you for your time today, and I will now turn the call back over to Darryl.

Thank you, Mike. I'd like to take this opportunity to recognize your impressive accomplishments and acknowledge your efforts in leading our company through a period of rapid growth. Mike oversaw a growth from just $37 million in revenues at the end of 2011 before he joined to today where we are projecting revenue to exceed $180 million. Our stability through this dramatic growth is a testament to what Mike was able to accomplish. Mike has been instrumental in building our infrastructure including what is on all accounts an exceptional financial department that includes his successor, Tricia Plouf. Mission accomplished Mike, and thank you again. As I mentioned in my shareholder letter, our business model is unique and can take years to understand. We try to find great people, put them in a position where they can learn our business, and prove that they can perform while fitting within our culture. We have found that this is the best formula for long-term success. Tricia now joins a leadership team comprised of numerous others, who were promoted from within based on their exceptional performance. For example, Ian Moffat came to us initially as Vice President of Operations and is now our Chief Operating Officer. Margi Tooth came to us as Vice President of Digital Marketing and is now our Chief Marketing officer. These are simply a few examples of our strategy, which I believe is working very well. To wrap-up today's call, the first quarter was a good start to the year and we look forward to building on our positive momentum throughout 2016. In the coming quarters, we expect to continue to add more pets to our book-of-business, build upon the relationships with veterinarians and their staff, enhance the customer experience, and reduce our fixed expenses as a percentage of our revenue. We will keep updating you on our progress along the way. We also have plans to be at several investor conferences in June, the details of which can be found on our IR website. Thank you all for your time today. Tricia is with us and all three of us will now be happy to answer any questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. And the first question comes from Jon Block with Stifel.

Great, thanks, and good afternoon guys. Maybe just the first one, the payout ratio, and I know the goal is a range of 18% to 21% and it was within that range at 18%, but at the lower end -- and I think Mike, you might have referenced an ARPU on a constant currency basis of up 6% to 7%. So Darryl, just taking a step back, can you just tell us what you guys are seeing with claims that it’s just reflective of the advanced level of care coming into the veterinary market, was any of the 18%, if you would, a little bit also a function as you continue to get more aggressive with the Express deployment?

Thanks for joining us. And thanks for the question, Jon. If you look at 18% to 21%, we were inside of our target. A factor to look at is this year we had a leap year, which gives us an extra day in the quarter. That one extra day is about 70 basis points so it would have been a little bit higher if you looked at it year-over-year. But it's within target, it's within our plans. So we are pleased with it. Tricia, I don’t know if you have anything to add?

Yeah. Jon, I would just add as we look forward to the rest of the year, there is some variability on a quarterly basis. We feel really confident overall in our 18% to 21% annual target. Seasonally, Q2 tends to have a seasonally lower gross margin so we are projecting that Q2 margin will be in line with what we saw for Q1. But overall confident in the annual range. And as you know our main focus area is on driving scale in those fixed expenses and expansion in our adjusted operating margin, which increased 600 basis points and that's our area of focus as we drive the growth going forward.

Okay, great, very helpful. Maybe just one or two more from me. Darryl, in that shareholder letter, you talked a lot about the number of active hospitals, I think it's 7,660. And just maybe, your thoughts on when you hit the switch and sort of focus the guys a little bit more on same-store sales or utilization rather than new active hospitals. And obviously, you mentioned the 7,600 and 28,000 you got a long way to go on active, but is there something you’re looking for whether it be hospital experience or whatever maybe to then shift their focus and go a little bit more in the utilization road, rather than new active hospitals.

I think for 2016, we're mainly going to be going wide. We need to build the foundation to build this category. We are, in some of our more established markets, working on same-store sales. But for most of 2016, the major focus will be like 2015 and trying to increase our -– the breadth. I think if you look in 2019 and 2020, that will be a time when hopefully we're mainly dealing with same-store sales, but right now we're still building a lot relationships. We've added a lot of Territory Partners, we're in new markets, and still at very early stages. I think we've mentioned before that in a territory, where a Territory Partner has been in the market for five years, that probably adds about little over 50% of active hospitals. So it takes us a number of years to just get past the gatekeepers and build those relationships so it's kind of foundational. If we focus on same-store sales right now, we don't have the capacity to go as wide at the same time. So, that's -- that will be the focus for the next year.

Okay. Perfect. And last one from me, I promise, just Mike or Tricia, just that bump to 2016 guidance that I know you changed the currency assumptions. But is it just -- I mean at the highest level is it sort of half and half or around there in terms of what is attributable to currency and what's attributable to underlying operations? Thanks, guys.

Yeah, Jon. I mean, I think roughly that's accurate. We flowed through our Q1 outperformance, so we're very happy with how we performed in Q1 and reflecting our confidence for the rest of the year. But as you know, we did have a 70% FX rate assumption at the beginning of the year and now we're using a 77% rate. So that's being flown through as well.

Thanks for your time, guys.

Thank you.

Thank you. [Operator Instructions]. And the next question comes from Michael Graham with Canaccord.

Hey, thanks very much. Congrats on the good numbers guys, and Mike sorry to see you go, but congrats on your retirement. Just a couple, the first is, there are on the category LTV differences, I'm trying to understand them a little better because I know you have more or less a cost-plus model. So I'm wondering is that category LTV difference basically driven by claims activity so like the margins are the same but the revenue is higher, and can you just maybe talk about that little bit like what are categories that do well on LTV and what are some that don't? And the second thing is as I just wonder, you talked a little bit about cohorts in the shareholder letter, but I was wondering about the vet hospitals that you brought on in 2015 and in 2014, in terms of the share of pets at those hospitals that are coming under insurance with you guys. How is that penetration trending in the cohorts, like the 2014 penetration, did it go up in 2015 and sort of is there a way for us to kind of get at the momentum that way?

Michael, thanks for the questions and your participation. Let's go with the first part. The way that I understand, that you want to understand, we have a different lifetime values by different subcategories. We report on a blended average, but as you guys all know we've collected over 15 years of data, have over $1.2 million price categories. A price category could be a dog or a cat or it could be a golden retriever or it could be somebody living in New York versus Boise, Idaho. What makes one lifetime value bigger than the other is the combination of a number of factors. The first one is, what is the average ARPU. So if we're charging a $100 a month versus $20 a month that is one factor. The second is, we all have the same target, we want to be paying out about $0.70 on the $1 in veterinary invoices. So were we good at estimating and were we good at getting the proper rate. And then the third factor on that is our retention rates, how long does somebody stay with us. And if you take somebody that is maybe a cat in Boise, Idaho, they might have a lower ARPU with high retention rates but our lifetime value might be half of that of a dog in Toronto. So we're trying to match up our pet acquisition costs for a lifetime value, so we're getting a good rate of return on all of these. And sometimes it's a -– you have a lower lifetime value and it's just a pricing mistake, we either estimated wrong or we didn't get the right rate, other times it's a retention issue. But what's most important for us is to make sure that we're spending our money effectively to get a good rates of return -- utilizing our capital in a good way, and sometimes those vary. Sometimes it's just operation errors and sometimes it's -- we're getting new information. And so, I think we're getting more granular over time. We're getting better at it. If we were really, really good, we would have a 5 to 1 ratio on $1.2 million categories. I can guarantee you we are not that good. You've seen the blended average. But as a strategic advantage in using our data, we don't typically want to educate the markets on what is higher and what is lower. So we're not really going to be breaking those ones down. That kind of goes go to the next part of your questions about cohort years by vet hospitals or so on. We think these are some of the strategic advantages, and to maximize those, we'll probably keep those to ourselves. But I can assure, everybody listening that’s something that we look at closely and we're always trying to get that same type of return that I talked about.

Yeah. Okay. Thanks a lot for that answer, Darryl.

Okay.

Thank you. And the next question comes from Andrew Bruckner with RBC Capital Markets.

Thank you and Tricia, congratulations on the promotion, and Mike, you'll definitely be missed. Wondering about your cash flow for the end of the year, do you think that you could be breakeven in Q3 and Q4? And also, do you spend any time thinking about the B2B or White Label business and expansions there? Thank you.

Thanks, Andrew. And I'll answer the first question, and then, Darryl can tackle the second one. In general when we think about the next couple of quarters, we're currently on track to be breakeven in Q2 or Q3 of this year. Darryl mentioned this in his latest shareholder letter. We think that Q2 will be really close. Regardless of that exact timing, Q1, we showed significant year-over-year improvement in our cash flow and then they looked towards the rest of the year. We can -- we anticipate continuing to see that type of improvement year-over-year, and sequentially, an increased improvement. I can't make any promises about the -- how the whole year will go in total but this is a priority for us, something that we're very focused on. The main areas that are driving this are consistent revenue growth, our focus on scaling our fixed expenses, and also, like Darryl mentioned being very disciplined at growing on a 5 to 1 ratio. And another big part of that, which we've seen in the past couple of quarters, is the decrease in spend that we're seeing for technology related to Trupanion Express being relatively behind us in terms of the significant development costs.

Andrew, let me see if I can kind of put a bow on what Tricia said. We think we'll be cash flow positive in Q2 or Q3. We're still hoping it's going to be in Q2, we think it's going to be close as I mentioned in the shareholder letter and I'm wait -- looking forward to see in the quarter progress to see where it ends up. But we feel like we're on the right trend line and things are looking positive. As far as your B2B comment, we have modest growth in that area. If we have anything that moves the needle in a dramatic way, it will be something that we will disclose to the market. But all of this is kind of business-to-business where if we get a block of business, it tends to come on in a block and then it will be built into you guys models moving forward. So inter-quarter, you won't see any big changes, and if we have any big announcements on the positive side we'll let you know, and the same side if we had a big announcement on the negative side, we would let you know. It is an area that we are trying to build but we don't think it has the same run rate as our direct-to-consumer monthly subscription business, which is as you know they are majority of all of our efforts.

Understood. And have you ever said anything on contract lengths or typical contract lengths?

Most contract lengths are annual on the B2B side. There are a few exceptions, some of that are monthly and some of that have longer periods, but I think in general, we look on an annual basis. So if we heard about something it would take about 12 months to roll off, and if something new came on it, on average, takes 12 months to roll on.

Thank you.

Thank you. And the next question comes from Kevin Kopelman of Cowen and Company.

Thanks. And I apologize if you've already talked about this, but can you just give us an update on what you're seeing in the kind of competitive environment clearly, pretty strong results or what are you seeing kind of on the ground? Thanks.

Thanks for the question, Kevin. We haven't seen any dramatic changes on the competitive landscape for a number of years. As a reminder to everybody, we started in Canada over 15 years ago. We've competed with over 40 brands. The number of brands in the marketplace is roughly the same. There has been a little bit of consolidation with some smaller marketing companies being acquired, but the brands still run independently so it doesn't really have any impact from the consumer side. Overall, there is a trend that higher value proposition, better quality products are growing at a faster rate than kind of the older, more traditional models that did not meet the needs of the consumer, so that should help the entire category. Most importantly, we believe the moats that we have as a company, starting with our data, our Territory Partners, the ability to pay directly with Trupanion Express adds to a very wide moats, and put us in a position to continue to be the category leader not just next year but for the next foreseeable future. So, we continue to watch it. I think there is some opportunity for us to do a better job, particularly on direct-to-consumer communications, explaining why our value proposition is better. I don't think that is one of our strong points so I thought we would have made better progress last year, but with everything we had on the plate, we didn't make as much as I'd like. So I think there is a good opportunity for us to do a better job, communicating our benefits directly to consumers. But remember, over 80% of all of our leads come to us are non-paid. They are either coming to us from veterinarians or existing pet owners. These people, all experienced and understand the benefit of Trupanion. And part of the reason that we've been able to have a great consistent growth. So I think we'll get better at explaining the benefits to a consumer, but overall, we haven't seen any meaningful changes in the competitive marketplace.

Thank you. And that does conclude the question-and-answer session, and the conference also has concluded. Thank you for attending today's presentation. You may now disconnect.