Trupanion Inc (TRUP) Q2 2020 Earnings Call Transcript

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Trupanion Inc (NASDAQ:TRUP)Q2 2020 Earnings CallAug 4, 2020, 4:30 p.m. ETContents:
Prepared Remarks
Questions and Answers
Call Participants
Prepared Remarks:
OperatorGreetings, and welcome to the Trupanion, Inc. Second Quarter 2020 Results Call. [Operator Instructions] [Operator Instructions].It is now my pleasure to introduce your host, Laura Bainbridge, Head of excuse me, Head of Corporate Communications. Thank you. You may begin.Laura Bainbridge — Head of Investor RelationsGood afternoon, and welcome to Trupanion’s Second Quarter 2020 Financial Results Conference Call. Participating on today’s call are Darryl Rawlings, Chief Executive Officer; and Tricia Plouf, Chief Financial Officer. Margi Tooth, Trupanion’s Chief Revenue Officer, will also be available for the Q&A portion of today’s call. 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-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, internal rate of return, 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 acquisition.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 Investor 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.And with that, I will hand the call over to Darryl.Darryl Rawlings — Founder and Chief Executive OfficerThanks, Laura. It was a strong quarter for Trupanion. Normally, I start with a review of our key financial metrics. This quarter, the metrics speak for themselves. So I’ll start with some context around our business performance. Just a few months ago, we moved our entire workforce remote against the backdrop of a steep and unprecedented economic downturn. Throughout this period of change, the team stepped up in support of our members and delivered on our promise to be there 24/7, 365. In times of uncertainty, the need to help pet owners budget for the unexpected is even greater. Across the business, we delivered record-breaking service levels from the speed we answer the phones, to how quickly we were able to pay veterinary invoices. These efforts manifested in record monthly retention in the quarter and a record number of pet owners adding pets or referring to friends.Improvement in these metrics paved the way for Nirvana, which we define as a state in which existing member referrals equal or exceed the number of members who cancel. I first coined this term in our 2015 annual shareholder letter. And those of you who follow the story closely know the significance of this metric on our ability to deliver self-sustaining growth in the future. At our Annual Shareholder Meeting in June, we highlighted Boston as our first U.S. territory to enter a state of Nirvana. Since then, we’ve made progress in additional U.S. and Canadian territories, bringing our total count of territories in Nirvana to 6. Churn for the trailing 12-month period averaged 1.34% per month. Our highly efficient Refer A Friend and Add A Pet channel comprised 0.75% of pets during the same period. The difference between the two, the gap to Nirvana, was 0.58%, a 16 basis point improvement over the prior year period. For the stand-alone months of May and June, the gap to Nirvana was only 0.43%.Maintaining service levels will be critical to continuing to drive Nirvana across the business. At the same time, our field sales team found new and creative ways of interacting with veterinarians and their staff. Relative to the prior period, we believe the total number of touch points actually improved in the quarter. Strategic changes in how we support our field sales team and additional engagement from our account managers strengthened the performance within this core channel. We ended the quarter with over 11,500 active hospitals, a number that has continued to grow in the third quarter. We saw good success outside the veterinarian in Refer A Friend, Add A Pet channels, as the team was able to dynamically adjust our pet acquisition spend in relation to market opportunities. This is not a new skill for Trupanion. The net result was stronger-than-anticipated performance in our subscription business.While we saw some benefit within our quarterly financial results, the nature of recurring revenue means the impact will be more meaningfully felt in the quarters and years ahead. So with that, I’ll review our key financial measures for the quarter. Total revenue grew 28% year-over-year, and we ended the quarter with over 744,000 total enrolled pets. Adjusted operating income grew 44% year-over-year to $14.1 million, $13.4 million of which was from our subscription business. Growth in our adjusted operating income sets us up well to deploy capital at attractive internal rates of return. During the quarter, we were able to deploy $8.4 million of our adjusted operating income in pet acquisition spend related to our subscription business at an estimated internal rate of return of 45%, above our 30% to 40% target. Our internal rate of return benefited from our record-high retention rates in the period, growth in our highly efficient Refer a Friend, Add a Pet channel and expansion in our adjusted operating margin.The combination of margin expansion and improved monthly retention increases the lifetime value of a pet and our allowable acquisition spend as a result, and we intend to be more aggressive in the second half of 2020. In the quarter, we saw expansion across key metrics: net pet growth, retention, lifetime value of a pet, growth in active hospitals and adjusted operating margin, all while being disciplined with our internal rates of return on invested capital. These results will positively impact the intrinsic value of our company. For a more detailed discussion of intrinsic value and how our business metrics influence it, please look to my 2019 annual shareholder letter, which we published in April. In summary, it was a very good quarter for Trupanion. Across nearly every metric, the team hit it out of the park, all while navigating through a period of unprecedented change. To the team, you came together in support of our members and their pets while raising the bar on our service levels. Well done. And on behalf of all shareholders, we thank you.With that, I’ll hand it over to Trish.Tricia Plouf — Chief Financial OfficerThanks, Darryl, and good afternoon, everyone. We are pleased with our strong financial results for the second quarter, which exceeded our expectations. Our overperformance was led by record monthly retention and solid growth additions in our subscription business and continued growth in our other business. Before getting into the results, I’ll provide high-level context for how our performance compared to our expectations. In late April, when we last provided guidance, our lead volume from veterinarians was down as much as 20% compared to the prior year. We’ve since seen wellness visits at the veterinarian rebound. Also in April, retention was consistent with historical levels after a slight decline at the end of Q1.We also have seen a slight reduction in the number of veterinary invoices, though it remains unclear how quickly volumes would begin to increase. In light of market uncertainties, we had pulled back our pet acquisition spending early in the second quarter, particularly our test spend. With that as backdrop, I’ll review our second quarter performance in more detail. Total revenue for the quarter was $117.9 million, up 28% year-over-year. Subscription revenue was $92.5 million in the quarter, up 19% year-over-year or 20% on a constant currency basis. Total enrolled subscription pets increased 15% year-over-year to over 529,000 pets as of June 30. Average monthly retention, which is calculated on a trailing 12-month basis, was 98.66% compared to 98.57% in the prior year period. We note that approximately 1,600 failed payment cancellations were deferred from Q2 into Q3 as a result of a change in process due to COVID. Adjusting for these cancellations, our retention rate would still be excellent at 98.64%.For additional context, retention for Q2 on a stand-alone basis and adjusted for those failed payments was 98.78%, our highest quarter on record. As a reminder, nearly 96% of our subscription revenue for a given quarter is from our existing book of business, demonstrating the impact of strong retention rates on our business model. Monthly average revenue per pet for the quarter was $59.40, an increase of 4% year-over-year or 5% on a constant currency basis. In local currency, U.S. ARPU increased 5% and Canadian ARPU increased 3% over the prior year period. Our other business revenue, which is comprised of revenue from our other product offerings that generally have a B2B component, totaled $25.5 million for the quarter, an increase of 76% year-over-year. Year-over-year growth in our other business segment reflects an increase in the number of pets enrolled.Subscription gross margin was 20% of revenue in the quarter, compared to 18% in the prior year period and within our annual target of 18% to 21%. Our subscription gross margin was comprised of 71.2% paying veterinary invoices and 9.2% variable expenses as a percentage of subscription revenue. During the quarter, we saw a reduction in veterinary invoice volume that increased our subscription gross margin by about 1% of revenue. Early in Q3, we have seen veterinary invoice volumes trending back in line with pre-COVID levels. Total gross margin was 17%, which includes our lower-margin other business segments. Total fixed expenses in the quarter scaled
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