Trupanion, Inc. (TRUP) Q1 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Trupanion First Quarter 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Laura Bainbridge.

Good afternoon, and welcome to the Trupanion first quarter 2017 financial results conference call. Before we begin, I would like to remind everyone that during today's conference call, we will make certain 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-K and 8-K filed with the Securities and Exchange Commission. Today's presentation contains references to non-GAAP financial measures that management uses to evaluate the company's performance, including, without limitation, fixed expenses, variable 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 stock-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 Founder and CEO.

Thanks Laura. And good afternoon, everyone. I am joined today by Asher Bearman, our Chief Administrative Officer; Tricia Plouf, our Chief Financial Officer is on maternity leave, having just given birth to her daughter a week ago. Before I jump into the details of the first quarter, I want to highlight that on April 26, we published our 2016 Annual Report which includes my third annual shareholder letter. I'll touch upon a few of the highlight today but I encourage you all of to give it a read as it provides some comprehensive insights into how we operate and think about our business. For a more in-depth discussion around the focus area is highlighted in the shareholder letter. I also would like to invite you to an upcoming meeting of shareholders which will be held on June 7 at our Headquarter here in Seattle. Our intention is for this event to be an annual opportunity for our shareholders to witness our culture, interact with our team and learn more about our key initiatives. Turning now to our high level results. It was another solid quarter financially. We grew total revenue by 28% year-over-year. We expanded our year-over-year adjusted operating margin by a 170 basis points to 8%. We continue to leverage our fixed expenses. We delivered our fourth consecutive quarter of positive free cash flow and we achieved our targeted LVP to PAC ratio of 5 to 1. We also continue to chip away at the key focus areas as I lay out in our annual shareholder letter. In some areas we made more progress than others but we are squarely focused on deepening the modes around the business. One of largest competitive mode is our national sales force of Territory Partners. In 2016, we increased the number of people in the field from 84 to 104, adding Territory Partners at both new market and in territories where we have more established presence. 80% of hospitals are located within these territories and we have a target of visiting these hospitals every two months. One of our main focuses in 2016 and continuing in 2017 had been on increasing same store sales. Historically, it has been difficult for us to focus on both adding new stores while increasing same store sales. And our active hospital growth in 2016 reflects this challenge. In 2016, the number of hospitals actively recommending Trupanion peaked at just over 8,100 hospitals compared to the 7,660 at the end of 2015. This is below the expectations that we had set out for ourselves going into 2016 but was reflective of our shifting focus around the middle of 2016 towards growing same store sales. As I discussed in the most recent shareholder letter, it's too early to tell whether the strategy will pay off but I feel good about our progress thus far. We begun testing new strategies centered around providing partnering hospitals with more data and information, enabled largely by Trupanion Express and previously unavailable to us. And we are doing so with an increased frequency compared to our historical touch point. We expect that this will be an important multiyear initiative. We ended 2016 with over 1,400 Trupanion Express enabled hospitals, up from 500 in the prior year but slightly below our prior target of 1,500 to 2,000 hospitals. This was deliberate and reflective of our strategy to better levered Trupanion Express as a tool to support our same store sales initiative. We paid over $30 million in claims directly to the veterinary hospitals in 2016, up 41% from 2015. And we are working diligently towards the day where 95% of our member invoices are paid directly and instantly to their veterinarian hospital. Acquiring pet through the veterinary channel remains our primary focus. And today, approximately 80% of our new enrollments are generated from veterinarian or from our existing member. In more matured market where the majority of veterinarians are actively recommending Trupanion, we believe we will eventually be able to cost effectively use medium such as television and radio to increase brand loyalty and conversion rate. We continue to test these alternative channels in strategic way. In the first quarter, we were slightly more aggressive in our direct-to-consumer testing as compared to 2016. The results were encouraging and we intend to continue targeted test throughout the remainder of 2017. Our ability to optimize LVP to PAC by sub category remained an important aspect to this effort longer term. We spent quite a bit of time in prior calls talking about our work in this area. And at a high level we made some progress by improving known pricing method. That said we have additional work to do to get our pricing as accurate as possible at the sub category level. You can find some additional detail thinking on this topic in our most recent shareholder letter. Longer term, our strategy is to continue to optimize our business in a way that drives higher lifetime value pet and thus enables higher PAC spend. This should allow for alternative acquisition channel within our LVP to PAC discipline. We use the internal rate of return on our pet acquisition spend to help and form the appropriate target for our LVP to PAC ratio taking into account our current adjusted operating margin. Moving forward, as we continue to scale our adjusted operating margin, we may start to adjust our LVP to PAC target based on our estimated internal rates of return. 2017 also marks the renewed focus on using our insurance entity American Pet Insurance Company to issue policies for other pet medical insurance brand. In the first quarter of 2017, our insurance entity began issuing policies for Pet's Best, a well established US provider of medical insurance for pet. This relatively new underwriting relationship is not expected to materially affect our financial results this year perhaps adding up to 20,000 pets to our total enrolled pet count over the course of 2017, so we hope that in partnering with Pet's Best we can help them continue to drive growth in their business over the longer term. This is one example of our strategy to develop business-to-business partnership to grow the category. Interesting product offerings and distribution models are likely to arrive, and we believe our infrastructure, people and data can help advance these models and niche product without distracting from our focus to increase the acceptance of the category. We increased the acceptance of the category by providing high quality medical insurance for the life of a pet and educating veterinarian and their staff of the benefit of Trupanion. With that I'll hand the call over to Asher to walk through the details of our first quarter results and to discuss our 2017 outlook in greater detail.

Thanks Darryl. And good afternoon, everyone. On behalf of Tricia and the rest of the team, we are pleased with our financial performance in the first quarter of 2017. Total revenue for the quarter was $54.7 million, up 28% year-over-year. Total enrolled pets increased 19% year-over-year to over 364,000 pets as of March 31. Subscription revenue was $50.2 million in the quarter, up 28% year-over-year and comprised 92% of total revenue. Growth was once again driven by increases in average revenue per pet, as well as growth in subscription enrolled pet. Total subscription enrolled pets increased 17% year-over-year to approximately 335,000 pets as of March 31. Monthly average revenue per pet was $50.50, an increase of 9% year-over-year. In local currency, monthly average revenue per pet increased by 9% from the prior year for our US members and by 6% from the prior year for our Canadian members. Average monthly retention was 98.58%, a decrease from 98.65% in a prior year period. Our other business revenue which generally is comprised of our revenues that has a B2B component, totaled $4.5 million. This 27% year-over-year increase reflects an increase in the number of pets in this segment attributable to our relationship with Pet's Best. Total enrolled pets in our other business segment was over 29,000 at quarter end. Subscription gross margin was 18% in the quarter within our annual target of 18% to 21%. For the quarter, fixed expenses represented 9% of total revenue, down from 11% in the prior year period, reflecting increased scale in our technology and general and administrative department. Adjusted operating income totaled $4.4 million in the first quarter compared to $2.7 million in the prior year period. Net loss was $1.5 million in the quarter. As a percent of revenues, adjusted operating margin expanded to 8% from 6% in the prior year period. We view expansion in adjusted operating income as one of the most important measures of shareholder value creation longer term, as it represents income generated from our existing book of business that is available to invest in new pet acquisition I now want to turn to our acquisition costs. In the first quarter we spent $3.9 million on pet acquisition compared to $3.8 million in the prior year period. This equated to an average of $128 per acquired pet with a corresponding average lifetime value of $637. Our LVP to PAC ratio for the first quarter was 5 to 1 compared to 4.9 to 1 in the prior year period. Adjusted EBITDA for the quarter was a positive $0.5 million compared to a loss of $1.1 million in the prior year period. We generated positive free cash flow of $1.4 million in the quarter. We are pleased with our ability to deliver four consecutive quarter of positive free cash flow and our goal is to continue this trend. We generated a net loss of $1.5 million, or $0.05 per share during the quarter compared to a net loss of $2.6 million, or $0.09 per share in the prior year period. We ended the first quarter with 29.8 million basic shares outstanding and 33.4 million shares outstanding on a fully diluted basis. At March 31st, we had $52.7 million in cash, cash equivalent and short investment. I'll now turn to our outlook for the second quarter and full year 2017. Revenue for the second quarter of 2017 is expected to be in the range of $57 million to $58 million representing 25% year-over-year growth at the midpoint. At this revenue range, assuming we do not adjust our target and we continue to hit a 5 to 1 LVP to PAC ratio, we would expect adjusted EBITDA to be around breakeven for Q2. Based on performance in Q1, we are increasing our outlook for the full year. Revenue for the full year is now expected to be in the range of $233 million to $237 million representing 25% year-over-year growth at the midpoint. At this revenue range, and again assuming we deliver an acquisition spend in line with the 5 to 1 LVP to PAC ratio, we would expect adjusted EBITDA to be in the range of $3 million to $5 million for the full year. Also, please keep in mind that our revenue projections are subject to conversion rate fluctuation between the US and Canadian currencies. For our second quarter and full year guidance, we used the 75% conversion rate in our projection, which was the approximate rate at the end of March. With that I'd like to thank you for your time. And we'll now turn the call back over to Darryl.

Thanks Asher. Before we open it up for questions, I want to take a moment to thank our investors for their continued support. For those of you who are considering becoming a shareholder of Trupanion, we encourage you to review our 2016 Annual Shareholder Letter which is now available on our Investor Relations website. We also have many investor relations activities planned over the coming week including hosting an Investor Q&A session following the Berkshire Annual Meeting, May 6 in Omaha. Participation at the upcoming Stifel Dental &Veterinary Conference and the Cowen TMT Conference both to be held in New York on May 31st and June 1st respectively. And as I mentioned earlier, hosting our upcoming annual meeting of shareholders at our Headquarter in Seattle. We look forward to speaking with many of you at one of these events. And with that I'll open the call up for questions. Operator?

[Operator Instructions] Thank you. Our first question comes from the line of Jon Block with Stifel. Please proceed with your question.

Great. Thanks. And good afternoon, guys. Darryl, maybe just to start with Territory Partners, the 104 that you called out versus the 84, I think this I know 104 in 2016 versus 84 in the 2015, but 104 was a little bit higher than I would have anticipated. I think in the early days you thought maybe 90 or 100 was close to full sales force, so maybe if you could just take a step back and what are your expectations for the Territory Partners over the next 12 or so months? Will that continue to grow or you sort of in the training mode right now get them up to speed and become that sort of same store sales utilization.

Thanks Jon. I'd expect that we are going to have modest growth over 2017 but we are definitely in a training mode. We've got a lot of Territory Partners that are in year one or year two. When we talked earlier several years ago about the number of Territory Partners, we were thinking more about the number of regions and what we've been doing as we are starting to test same store sales and a bunch of other things is we are starting to add some additional Territory Partners in some of our existing more matured market. So if you take this like a Coca-Cola distributor adding a second Coca-Cola truck to an area. So we are going to continue to test and see how that goes, but I'd expect modest growth and lot more training in 2017. We've got probably 10 open territories that are like Charlotte, St. Louis, Pittsburg, and Minneapolis that we are trying to fill. We have some that will turn over this year as we know it's challenging to get Territory Partners through the first couple of years. But we are encouraged with what we see.

Okay, great. Maybe just two more for me. Sort of backing into flattish gross add number year-over-year but that was against your toughest comp in 1Q, 2016. So maybe just your thoughts around the gross additions this year. I know you got some initiatives out there that making traction throughout 2017. So as we get to that part of this year now this is a situation where you think as a company you recaptured some growth in that gross addition number.

You are right that we are looking at a lot of testing and long-term initiatives, same store sales and direct-to-consumer. We are also trying to fix some of our pricing by sub categories. But as I have -- Asher gave in the guidance earlier; we are on the top end of our range of trying to grow into 20% to 30% year-over-year. I think we are more going to be focused on learning and getting our initiatives right this year which will set us up for longer term for 2018, 2019 and 2020 to have sustained consistent growth rather than trying to put our foot on the accelerator just on the back half of the year.

Okay. Last one for me, in that shareholder letter that you alluded to, I believe there was part of the letter where you talked about an initiative or maybe a couple of initiative that were yielding good returns, it was early, you seemed somewhat cautious in the writing but anything that you can provide more color on what that maybe? And even at the high level is it specific to direct-to-consumer? I am not sure if you want to give some more color there. Thanks guys.

Thanks Jon. I am not going to give lot of color on it but I'll say that this is more about us trying to increase brand awareness and therefore increased conversion rate in some of our more established market rather than an initiative trying to drive new lead. The majority of the people that end up enrolling with us are puppies and kittens. Those people all touched the veterinarians and we are trying to reinforce in regions and markets where we have a high number of active hospital. So most of our testing is driven around places where we have density, have already built our brand recognition and seeing if we can continue with that trend.

Our next question is from the line of Mark Argento with Lake Street Capital. Please proceed with your question.

Good afternoon, Darryl. Just wanted to drill down a little bit, I think you made a comment about looking at kind of market by market, depending upon kind of penetration rates, maybe thinking about adjusting that LVP to PAC ratio. Is there anything in terms of -- I am assuming maybe getting little more aggressive on the customer acquisition side, is there anything any type of penetration rates that you are looking at or what would be some of the things that we could witness or you'd like to witness before you getting more aggressive with the ratio in some of those markets.

Well, the biggest thing to drive are adjusting our target ratio is really seeing continue trend in our adjusted operating margin. So two years ago that was about 1% and we are trying to get now kind of in the 8% range. When we start to get to the 9% and 10% range if you look at my most recent shareholder you'll see that we can start to get internal rates of return that are higher than what we've achieved in 2015 and 2016 while targeting and I'll repeat a PAC ratio to allow us to be a little bit more aggressive. So that's the principal driver for us. So our adjusted operating income is something that's been compounding over time. So it's getting bigger because our book of business growth, but it's also compounding because we are getting margin expansion. That gives us a bigger pool of money to be able to reinvest. The second thing is by having better internal rates of return means we get to cash flow breakeven earlier which can have us be a more aggressive. We will probably be testing those in market where we probably have a greater establishment and maybe higher conversion rate than brand new markets for us because this is not about just any company writing a check and creating awareness. This is really about trying to create acceptance for this category and acceptance is driven from by the vet and if we can help the veterinarian so that when they initiate a conversation about Trupanion that the client says though I've heard about them or can you tell me more about them, I think that's where we are going to go but it's still -- it's really early days. And I don't know if it's going to be radio or TV or Facebook or magazines that are going to be the best outcome for us. So this year we are just going to try to continue to test until we see things that are repeatable.

Right. Anything on the competitive environment side, any new entrance to the market obviously you need twist here providing underwriting services to I guess technically a competitors. Any thoughts on what you are seeing out there right now?

Yes. I mean no big changes. The total number of brands in the marketplace has been fairly consistent for the last five years. There is nothing that has us changing our short-term or long-term strategy. Competitors ebb and flow over time. I mean who are our stronger competitor three and four years ago change but the short answer to it is no, nothing significant. What we are doing with Pet's Best is demonstrates how we think we can be good partners so people try to enter the space. With our data, the team of people that we have, our focus if there are companies that have unique distribution channel or unique product, we think we can actually be really helpful and that help create growth in the category and acceptance in the category without distracting from our focus on the veterinarian channel and the key to growing this business.

And our next is from the line of Michael Graham with Canaccord. Please proceed with your question.

Hey, thanks a lot. Darryl, I just wanted to ask -- well first of all, I think you gave us I apologize but last quarter you said 17% of pets were unprofitable, I am just wondering how that changed and sort of what you've done there over the last two months and then I just wanted to also ask about the lifestyle of vet once they -- the lifecycle of a vet once they come onboard, in another words in a first year versus like the second and third year do you see a much higher penetration of the pets that they are caring for? Do they end up steering more of them over towards your product?

Let me get your second question first which is a really intuitive and mar question about what behavior change as years pass with the veterinarian recommending us. Historically, that has been the only driver that we've had for same store sale. So a hospital has been recommending for us one year does not recommended as many pets in a given month or a period of time as somebody has been recommending us for five years. So the more that people get used to it we live up to what we say. They get pets enrolled and after wait a year or two until they have a major medical problem and then they see us doing what we say, then they recommend us with more confidence in the future. So that is a something that's been historical, a trend that we've seen for the last 15 years. We are trying to do a few things to try to accelerate that. When we talk about some of our same store sales initiative that's mainly driven around using some of the information that we get from Trupanion Express, trying to have more touch points so we can get back to them more in a frequent basis. But you are -- your intuition that a hospital recommending us for five years recommends us more than one that three years or one year is correct. And it's an important part of our business model. The first part of your question was about we mentioned in the past and there is a lot more details about this in the shareholder letter. If you haven't had a chance to read it yet about how we are looking to have each of our sub categories optimize where we are providing $0.70 on the $1 value proposition to all of our pet owners and then trying to line up our acquisition spend to the appropriate dollar amount. We continue to chip away we are making progress it's not something that I plan on giving visibility to on quarterly basis because quarter-to-quarter it doesn't mean much. But I'd say on annual basis I am expecting to see good progress a year from now. I'd like to see that number eventually less than 5% and I think in 2017 we will definitely chip away that and feel good about at the end of the year.

The next question is from the line of Andrew Bruckner from RBC. Please proceed with your question.

Thank you. I just want to follow up with question on Express and given the hospitals is quite where you thought they were going to be, are you seeing actually more revenue dollars flow through them than you would initially thought or claims dollars rather? And do you have any details on to new hospital rather actually ever go on Express immediately or are they only for more seasoned hospitals? It's not worth initial spending expense.

So let me give you some insight into. We went from about 500 hospitals to 1,400 with Trupanion Express enabled slightly below what we would have anticipated going into the year. What we've found is Trupanion Express beyond having a great customer experience is giving us information to help us with other initiative. But to do that we wanted to slowdown a little bit and train people appropriately so we are trying to balance the go out quickly and have later touch with having kind of appropriate return. We are seeing slight revenue improvements in these hospitals, claims cost are coming in right where we expect them to be so no surprises there. But what we are really happy about is Trupanion Express is a more valuable tool than we originally initiated from all aspects of our relationship. And that includes brand new hospitals that are coming on board and saying I otherwise would not be interested in this category without it. So hospitals that have had no previous experience to ones that we have been working with us for three years that are saying when I can get onboard. We have greater demand than we do have our ability to deploy at this point. Our biggest constraints are really internal and making sure that we do it effectively. If I look at our operational challenges over the years when I try to accelerate just for the sake of acceleration, I wanted to go back and slow things down. And this one I think we are balancing it between speed and quality. Is that answered your question?

There are no additional questions at this time. And this will conclude today's teleconference. Thank you for your participation. You may now disconnect your line at this time.